Opportunity Cost: What Does It Mean?

Opportunity cost is a term that is regularly used in the investment world. As an investor, you will need to evaluate the opportunity cost of many different scenarios when making a decision. Here are the basics of opportunity cost and what it means to you as an investor.

Opportunity Cost

The term opportunity cost deals with the choices that you make on a regular basis. When you choose one thing, you are choosing not to pursue another opportunity. The opportunity that you did not pursue is known as the opportunity cost. Many times, the opportunity cost can be represented by a monetary value. This is the amount of money that you did not receive because of the choice that you made.

Example

In order to understand the basics of opportunity cost, it is helpful to use an illustration to better grasp the concept. For example, let's say that you were trying to choose between two different careers. You could not decide whether you wanted to be a business owner or a dentist. Although you can look at the average salaries of business owners and dentists, there are many other variables that will be involved in your decision. For example, you have to look at how much formal education you will need in order to become a dentist. This means that you have to calculate how much money you are going to be spending on school and how much time it will take for you to start working as a dentist. On the other hand, you will have to consider the necessary steps that it will take to become a business owner. You will have to potentially get a business degree and come up with the capital to start your own business. If you choose to pursue a career as a dentist, you are foregoing the opportunity of becoming a business owner. In this case, becoming the business owner would be your opportunity cost. You made the decision that you believe the dentist position has the greatest potential and you are going to give up the opportunity to become a business owner in order to pursue that career.

Investing

This concept is regularly considered when people are choosing investments. In order to invest in something, you are going to be giving up the opportunity to invest in another security. Let's say that you choose to invest $1000 in a particular stock that only provide you with 3 percent over the course of a year. At the same time, you could have invested in a different stock that paid 7 percent over the course of the year. The stock that paid 7 percent would represent your opportunity cost in this scenario.

Investment Considerations

Whenever you are choosing in the investment, you will have to be aware of the opportunity costs involved. This means that you will have to take special care to choose the best opportunities for your investment funds. Otherwise, you could be giving up substantial returns in the long run.

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