Just what is opportunity cost?

Opportunity cost is one of the most fundamentally important items one must have an understanding to succeed in the game of life. Opportunity cost is the price you sacrifice in order to complete another task and this can greatly impact your financial path. Time should be treated very sacredly which is why this will heavily sway the decision you make as making the correct decision will accelerate your outlook. To an investor, opportunity cost means that your investment choices will impact your short-term outlook or long-term outlook as you could have invested that money another way.

• Alternative definition: Opportunity cost is price you pay to make a gain it could be time used which you could have used for something else.
• For instance, the choice between whether to sell stock
• shares now or hold onto them to sell later is an opportunity cost. You can
• sell now and use that money to for something else, but if the stock rises and
• then you lose out on that portion. Of course, you could have used that money from
• selling to invest in another stock which has a better outlook. While it is true
• that an investor could secure any immediate gains they might have by selling
• immediately, they lose out on any gains the investment could bring them in the
• future.

Another common example of everyday opportunity cost could be something as simple as choosing between going to work and skipping work. Going to work you gain money skipping work you would not make money that day, but skipping
work to take care of health is could outweigh money so make wise decisions. Opportunity cost is a game played all throughout life, weigh all decisions beforehand, it’s a good idea to list out the pros and cons.

How Opportunity Cost Works

Let’s say you are now facing a difficult financial decision, first step you should take would be to determine the return you’ll get from each option. For example, let’s say you’re entertaining the thought of selling a stock and using the money you’ll gain to invest in another company you believe as a better long-term outlook. Below is a great example you can use to visualize your decision:

Let’s say your current stock “A” has a value of $5,000, you can sell it to help purchase stock “B” at a lower price. Stock “B” has a face value of $5,000—so they are both the same price this is sort of like a trade exchange “B.” To better determine a better outcome, you need to weigh both options.

The initial cost of stock “B” is the same that of “A,” so it would take the same investment amount to make the switch.
Now this would only make sense if you believe stock “A” does not have as much potential as stock “B”. After doing your due diligence, you believe stock “B” can outperform your current investment

In this example, you are now no longer investing in stock “A” which could take off or go down, so at the end of the day its best to always do your due diligence and weigh your opportunity cost before making the decision.

It is super easy to look back and compare your decisions made in hindsight, you don’t always win but visualizing your decision could help you make a better one.

How To Calculate Opportunity Cost

There are not one size fits all way to measure Opportunity Cost, however a great way is to quantify the estimate of the potential future value that you opted not to receive and compare it with the value of the choice you made instead.

For an example, opportunity cost is a common-sense concept that economists and investors would like to implant in creating a game plan. For example, what would have happened if Elon Musk did not sell PayPal to fund is plan for Tesla? By making that decision not only has he accumulated wealth he innovated the whole car industry and how it should be run. (Subscription based modeling) Opportunity cost is the name of the game, with dollar signs on each path taken, there is something to gain and lose in each direction.

The Game of Opportunity Cost

Understand you cannot be two places at once, so you can’t work two jobs at the same time. You need to either find ways to create income passively or find ways to reduce time spent on each task. Every choice made in life has an opportunity cost and it will be reflected down the road.

Explicit Costs

For investors, explicit costs are direct, out-of-pocket payments such as purchasing a stock, or spending money to improve assets such as properties. Costs can also be wages, utilities, materials, rent or even time spent closing
deals. For example, if you own a cafe and a new item added to the menu that requires $100 in labor, ingredients, electricity, and water, your explicit cost is $100.

Your opportunity cost is what you could have done with that $100 had you not decided to add the new item to the menu. That $100 could have been spent advertising or spending on employees for morale. Explicit and implicit costs can be viewed as out-of-pocket costs (explicit) and costs of using assets you own (implicit).

Implicit Costs

Implicit costs do not represent a financial payment as they are not direct costs to you but rather the lost opportunity to generate income through your resources. A good example would be you have a second house used as a vacation home so the implicit cost is the rental income you could have generated if you leased it and collected monthly rental checks since it is not always used. It doesn’t cost you anything upfront to use the vacation home yourself, but you are giving up the opportunity to generate income from the property if you choose not to lease it.

Super Takeaways

• Each
  decision made always has opportunity cost.
• Opportunities
  cost result in gains and losses.
• Opportunity
  value less actual gain is an estimation of the opportunity cost.
• The
  same choice will have different opportunity costs and will result in
  different outcomes for each person.