Every decision must be judged against the best alternative use of your resources.
When evaluating an opportunity, we naturally ask whether it is attractive.
Is this a good investment? Is this a promising business? Is this project worth pursuing?
But these questions overlook something fundamental.
An opportunity can be genuinely good and still be the wrong choice if a better alternative exists.
This is the principle of opportunity cost: the value of the best alternative we give up when making a decision.
For Warren Buffett, Charlie Munger, and Howard Marks, it is one of the most important principles of capital allocation.
The Best Alternative Sets the Standard
At Berkshire Hathaway’s 2001 annual meeting, Charlie Munger explained:
“We have to compare it to the best alternative investment we have at that time.”
This is a different approach from evaluating investments against an arbitrary standard of attractiveness.
Munger illustrated the principle in 1997. If an investor already has an opportunity superior to 98% of the alternatives available, there is little reason to spend time considering those inferior alternatives.
Buffett explained that when Berkshire evaluated a new business, the question was whether they would rather own it than additional shares of Coca-Cola or Gillette.
The standard for a new decision is not whether it offers something valuable, but whether it offers more value than what we must sacrifice to pursue it.
The Hidden Cost of Decisions
Howard Marks explores this principle in his 2022 memo, Selling Out.
He observes:
“Selling an asset is a decision that must not be considered in isolation.”
Selling an investment produces cash. But what will that cash earn? Would another investment offer superior risk-adjusted returns? Would holding the existing asset be better?
The same reasoning applies when considering whether to buy, hold, sell, or wait.
Even doing nothing has an opportunity cost.
Munger highlighted this at Berkshire’s 2001 annual meeting when discussing errors of omission: exceptional investments that Berkshire recognized but failed to pursue.
These missed opportunities never appeared as losses in financial statements, yet Munger considered some of them among Berkshire’s costliest mistakes.
The largest cost of a decision may be the value of what we never pursued.
Why This Matters
Opportunity cost extends beyond investing.
A founder who commits to one business opportunity sacrifices the capital, time, and attention that could have been devoted to another.
A manager who funds a mediocre project cannot allocate those resources to a more promising initiative.
And an investor who holds a satisfactory business may overlook an exceptional alternative.
The important comparison is always between realistically available choices—not imaginary opportunities or outcomes known only in hindsight.
The Practical Principle
Before committing resources:
- Identify your best alternative. What would you realistically do with the same resources instead?
- Compare expected outcomes. Consider returns, risks, time horizons, and confidence in your estimates.
- Include the option of waiting. Cash and uncommitted resources preserve flexibility for future opportunities.
- Recognize hidden sacrifices. Account for time, attention, and opportunities that will become unavailable.
- Reevaluate when alternatives change. A decision that was best yesterday may no longer be best today.
Opportunity cost is personal and situational. The best alternative for Buffett may not be available or suitable for someone else.
The fundamental insight is that a decision cannot be evaluated intelligently in isolation. Its value depends on what else we could have done.
The question is not merely:
Is this a good opportunity?
It is:
Compared to what?
References
- Munger, C., & Buffett, W. (1997). Berkshire Hathaway Annual Shareholders Meeting. Discussion of opportunity cost and comparing investments with existing holdings.
- Munger, C., & Buffett, W. (2001). Berkshire Hathaway Annual Shareholders Meeting. Discussion of opportunity cost as an investment standard.
- Munger, C., & Buffett, W. (2001). Berkshire Hathaway Annual Shareholders Meeting, Morning Session. Discussion of errors of omission and missed opportunities.
- Marks, H. (2022). Selling Out. Oaktree Capital Management, January 13.
- Munger, C., & Buffett, W. (2003). Berkshire Hathaway Annual Shareholders Meeting. Discussion of opportunity costs, investment hurdles, and future alternatives.