How Opportunity Cost Affects You As An Investor?
For instance, whether it is investing in one stock rather than another or simply opting to study for a big math exam instead of going to a friend’s house for pizza, opportunity cost pervades all facets of life. This is ultimately because every time you choose one option instead of the other, it means you’ve lost something.
That would mean simply what you lose when you have to choose between two alternatives, opportunity cost: core investment-defining concepts: as well as, perhaps more importantly, life in general. For instance, opportunity cost might define the amount of money you might not earn by purchasing one asset instead of another when it comes to investing.
Adem Selita states that opportunity costs essentially refer to wherein one may have asked, ‘What else could I do with this capital?’ and whether or not the money was adequately allocated.” Opportunity costs can be explicit costs, such as using your dollars on one thing instead of another, or implicit. The latter won’t pinch your pocket but will cost you the possibility of being able to do something else with your time or energy, which can have a knock-on effect on your finances.
Here is another way of thinking about opportunity cost, according to the most legendary value investor of all time, Warren Buffett: “The purchase has no more cost than the dollar expenditure incurred; the real cost of that purchase is the opportunity cost: the value or return on the investment not made due to the diversion of funds into a purchase.”
How To Calculate Opportunity Cost?
“According to Todd Soltow-both co-founders of Texas-based Frontier Wealth Management, economics might be fairly defined to include opportunity cost of Expected Return on Forgone Investment Option (FO) minus Expected Return on Chosen Investment Option (CO). The formula for opportunity cost is:
Opportunity Cost = Forgone Option – Chosen Option.”
How Opportunity Costs Impact You as an Investor
Of course, every investment decision is inherently influenced by opportunity cost. However, knowing that opportunity cost has to be weighed could imply there are too many opportunities to consider. You do not want to make a bad investment and incur the wrong opportunity cost.
Doug Milnes, CFA in MoneyGeek.com, NY, asserted the following: “The next step is naturally to assess the potential return on every stock, bond, art piece, NFT, and cryptocurrency available for investment” to try and optimize your returns. Thankfully, years of research and analysis have given us portfolio theory that will prevent investors from having to put so much effort into evaluating every investment opportunity.
These are the dictum portfolios designed to indicate the percentage of every type of asset investment so that you can ameliorate your uncertainty in any one asset or asset class going either way over time. “This simply reduces the investor’s decisions from each opportunity to a more controllable question, ‘How much of each asset class should I hold?'” he indicates.
These asset allocations can usually be advocated according to the time frame that the investments will be made and the risk that you are willing to take. The shorter your time frame, the more affection you will generally hold for conservative investments, like bonds and bond funds. For longer-term purposes, exposure to an increasingly greater proportion of riskier investments, like equities and equity funds, can be brought in to position you toward the higher end of potential returns.
It is worth repeating that regardless of the alternative you choose, opportunity costs will attach themselves to it. Not making a decision is, in itself, a decision entailing costs especially when the insidious costs of inflation are taken into account. “In life resources are limited; most importantly the commodities, services, money and time,” says Sweta Bhargav, a financial advisor at Advisor Wealth in Philadelphia, PA. “Those trade-offs always have to be made.” Opportunity cost is nothing more than a choice as to what trade-offs one can endure.
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