When you have a conversation about investing, it’s important to understand the lingo that accompanies. Often times when people discuss opportunity costs, they talk about the web of decisions we make in our lives. For example: I spend so much of my time studying and working just to get this new job – but I’m going to be in debt for 30 years! That’s an emotional way of saying opportunity cost: what I could have gained, if only I had put more effort onto a different path.
Basic Concepts of Opportunity Costs
An opportunity cost is the financial cost of the best alternative use that you have for a scarce resource. These resources can include money, land, knowledge and time. If a person was given an opportunity to make $1,000 today or $2,000 in 6 months, they could either invest the $2,000 ($1,000/6 = $833 per month) or they could spend the money on something else.
Formula for Opportunity Cost
The formula for opportunity cost is T = TVC where T is the total value and V is the variable (in our case growth rate). The variables in the table below represent some common investments. An opportunity cost is the cost of turning away an otherwise profitable investment. The formula for calculating your investment’s opportunity cost is the discounted value of all future earnings less the net expense.
How to Calculate the Opportunity Cost of Holding an Investment
An asset can be very different from other types of ownership. The future production of an asset is in no way logical when considering an opportunity cost for holding it. This uneducated mathematically minded individual always seems to place too much focus on the single piece of paper when it comes to analyzing something like the opportunity cost for buying or selling stocks.
How to Ensure That You’re Making the Right Decision for Your Financial Needs
To decide how to invest your money, you first need to figure out if you’re spending more than you are earning. A dollar saved is a dollar saved. The process of paying a variable cost for borrowing capital generally earns a lower return than saving since it returns the same cost without receiving interest. Well, before we dive into the world of opportunity cost, you should first know that this phrase is used commonly by those who invest in stocks with an end goal of profit. Essentially, it’s another term for investment risk. Opportunity cost looks at the types of investments out there in which one investment uses up what could have been achieved with a higher yielded investment. So let’s say James has $10k to invest. He can compare two stocks: ABC stock that has a yield of 10% and XYZ stock that is also at 10%. The opportunity cost to James would be considered XYZ; he would not have had $10k if he invested in XYZ instead of ABC.
Opportunity costs are the cost of achieving a gain. In this case, they might be paying more taxes than maintaining your current lifestyle while investing. One option to increase your wealth is to move overseas in order to lower your tax rate.