Calculate opportunity cost of investment

Opportunity cost of an investment is said to be the cost of giving up on an investment over another investment that would have been more profitable with better returns. It said to be the benefits an investor could have received but forfeited it in other to venture into another investment. Opportunity cost of investment is an alternative give up on an already made investment decision.

The choice of an opportunity cost is made between several clashing investment alternatives. If the best investment choice is maid, opportunity cost is the cost incurred by giving up on the benefits that would have been acquired by taking the alternative investment choice.

When investors assess the potential profits of different investment, mostly, they look for the investment that is likely to yield increased return which can be determined by the expected rate of return for a particular investment but in every investment, one must consider the opportunity cost of each. For example, if given a particular amount for an investment in which the investor have to choose between investing the money in securities or for the purchase of new assets, no matter the option that is chosen, the return that is forfeited by not investing in the other option is what is called an opportunity cost of investment.

CALCULATING OPPORTUNITY COST OF INVESTMENT

Calculating the opportunity cost of investment is the difference in return between a chosen investment and the investment that is necessarily passed up. The calculation of opportunity cost is expressed as return of most lucrative investment minus return of chosen investment.

Opportunity cost of investment = return of most lucrative investment – return of chosen investment.

THE IMPORTANCE OR BENEFIT OF OPPORTUNITY COST IN DECISION MAKING

The evaluation of opportunity cost is a great asset when it come to an investor’s day to day decision making on what to invest his money on and what not to invest on. Let’s take for an example in choosing between to invest your capital in the purchase of a house and to invest of capitals in a business. Each of this investment choices has a benefit and a draw back.

If the investor chooses the house, he will surly have a nice home and more comfort to himself and if he chooses to invest his money into business, he will forfeit the home and comfort of his own building but have the chance to earn more interest, profit and return in his business. This particular decision will give him more money in future but either way, he stands to gain or lose something. So, every time a choice is made by an investor, he weighs the opportunity cost of his actions.

In conclusion, keeping the concept of opportunity cost in mind is good in other to get the highest possible return but it should never be a prime consideration in an investment because it can lead an investor to take one more risk than he should have only in the effort of making profit.

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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