How to calculate opportunity cost in everyday life

It’s obvious that decisions around what to invest in are inherently informed by opportunity cost. But once you understand opportunity cost is a factor you should weigh, the amount of opportunities to consider may seem intimidating. You don’t want to choose the wrong investment option and incur the wrong opportunity cost, after all.

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Sum of invested cash, and interest, after tax, and adjusted for inflation. “It’s about thinking beyond the present and assessing alternative uses for the money—that is, not being shortsighted,” she writes. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs.

• The opportunity cost of a future decision does not include any sunk costs.
• For example, a stock with a potential 10 percent annual return has more risk than investing in a CD with a sure-fire 5 percent annual return.
• “Sunk cost refers to the past costs that you have incurred,” says Ahren A Tiller, Esq., Bankruptcy Law Specialist.
• Alternatively, if an individual spends $20,000 on a sedan, he cannot put that same amount toward a minivan.
• Robert Johnson, a professor of finance at Creighton University, points to a classical example of the returns caution-minded investors miss out on when they downplay stocks in favor of more secure investments long term.

In everyday life

So the hurdle rate acts as a gauge of their opportunity cost for making an investment. Investors might also want to consider the value of time in their calculation of opportunity cost. On one hand, you have a high interest rate for a longer period of time, but on the other,  your money is tied up https://www.bookstime.com/ that much longer and unavailable to you to invest in something else. Consider a young investor who decides to put $5,000 into bonds each year and dutifully does so for 50 years. Assuming an average annual return of 2.5%, their portfolio at the end of that time would be worth nearly $500,000.

Investment/financial opportunities

• Similar to the way people make decisions, governments frequently have to take opportunity cost into account when passing legislation.
• If your current bond “A” has a value of $10,000, you can sell it to help purchase bond “B” at a slightly lower rate.
• If you choose to have one thing, it usually means you have to forego something else.
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His work has appeared on TheStreet.com, US News, CBS News, Fox Business, MSN, Motley Fool, and other major business media platforms. As with many missed opportunity cost similar decisions, there is no right or wrong answer here, but it can be a helpful exercise to think it through and decide what you most want.

• This trade-off may either be something tangible (like money) or something intangible (like time).
• When you decide, you feel that the choice you’ve made will have better results for you regardless of what you lose by making it.
• A sunk cost is money already spent at some point in the past, while opportunity cost is the potential returns not earned in the future on an investment because the money was invested elsewhere.
• Imagine that you have been saving some extra money on the side to make some purchases, and on your most recent visit to the video store you come across a special sale on a new video.
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• It’s obvious that decisions around what to invest in are inherently informed by opportunity cost.

The opportunity cost of choosing to invest in Company A versus Company B is 10% minus 6%. With that choice, the opportunity cost is 4%, meaning you would forgo the opportunity to earn an additional 4% per year on your funds. As a result, individuals inevitably face trade-offs when making decisions. For example, if an investor decides to put $100 into ABC stock, that is $100 he cannot put into XYZ stock, or alternatively, some other kind of asset, for example a bond.

• Over the course of a year, $15 every week day would add up to thousands of dollars, money that could potentially pay for a nice vacation.
• Even making no decision is itself a decision with costs, especially when you consider the sleeper costs of inflation.
• The initial cost of bond “B” is higher than that of “A,” so you’d spend more hoping to gain more because a lower interest rate on more money can still create more gains.
• “It’s about thinking beyond the present and assessing alternative uses for the money—that is, not being shortsighted,” she writes.

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Accounting is not only the gathering and calculation of data that impacts a choice, but it also delves deeply into the decision-making activities of businesses through the measurement and computation of such data. For example, a stock with a potential 10 percent annual return has more risk than investing in a CD with a sure-fire 5 percent annual return. So the opportunity cost of taking the stock is the CD’s safe return, while the cost of the CD is the stock’s potentially higher return and greater risk.

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Informing Decisions With Opportunity Cost