Evaluate the value of foregone choices and optimize your decision-making.
Opportunity cost represents the potential benefits an individual, investor, or business misses out on when choosing one alternative over another. It is a concept often applied in finance and investing, helping investors weigh the cost of one investment over another, factoring in both potential returns and risks.
The formula for calculating opportunity cost is:
Opportunity Cost = (Return on Investment 1) - (Return on Investment 2) × Investment Amount
For example, if you are choosing between two investments where Investment 1 has an 8% expected return and Investment 2 has a 6% return, with an investment of $10,000, the opportunity cost would be:
Opportunity Cost = (8% - 6%) × $10,000 = $200
Opportunity cost helps you make more informed financial decisions by comparing the potential returns of different investments. By understanding the opportunity cost, you can make choices that maximize your financial returns, minimizing regrets over what could have been had you chosen differently.