The opportunity cost: Concept and importance in decision making

The opportunity cost: Concept, examples and importance in making financial decisionsThe opportunity cost is a key concept when making financial and non-financial decisions. Therefore, in order not to commit investment errors It is essential to understand this concept and also apply it. Next, we will see what the opportunity cost consists of, along with its importance when making decisions and a couple of examples of its application.

The opportunity cost (video)

What is the opportunity cost?

The concept of opportunity cost was first coined bydiversification It is essential to mitigate the risk of our investment portfolio, we will not take it into account in these cases.

Suppose we have only two investment options, both with the same risk, but with different returns.

  • Option A: 7% return
  • Option B: 10% return

In this case, if we invest in option A we would be losing money.

Why would we lose money if the profitability is 7%?

We would lose money because we would stop earning 10%. In other words, due to the opportunity cost of not allocating resources efficiently and earning 10%.

What if we added a third option? Suppose we now have three options:

  • Option A: 7% return
  • Option B: 10% return
  • Option C: 15% return

In this case, we would lose money with option A and option B. Therefore, the opportunity cost can vary over time for different reasons. For example, with the appearance of new opportunities or with changes in current opportunities.

As you can see, the opportunity cost is a key concept when investing in the stock market and making financial (and non-financial) decisions. This is because we have limited resources (time, money, etc.) and we must allocate them in the most efficient way possible to optimize their use. Therefore, you should never overlook it if you want to maximize the profitability of your assets when investing in the stock market.