Opportunity cost and investing - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Opportunity cost and investing

Nov 18, 2008

The concept of opportunity cost is something that we come across in our daily lives. We use the concept when it comes to making decisions involving a variety of options. For example, what are the different activities one could do on a Saturday evening? Either spend time at home with family or go out with friends or go out for dinner or to a movie.

Opportunity cost is defined as the cost of an alternative that must be forgone in order to pursue a certain action. It's the benefits one could have received by taking the next best alternative action.

Let us suppose an investor has the option of investing in a risk-free instrument such as a fixed deposit and stock A. Based on his assumptions he expects stock A to generate a 15% return over one year, while the fixed deposit will guarantee a return of 8%. In this example, if the investor chooses stock A over the fixed deposit, the guaranteed 8% return is his opportunity cost.

Charlie Munger explains this aptly - "Everything is a function of opportunity cost. The concept of a hurdle rate makes nothing but sense, but a lot of people using this make terrible errors. I don't think there's any substitute for thinking about a whole lot of investment options and thinking about the returns from each."

What Mr. Munger explained very well is that every time an investor decides to invest in a stock, he should always look at the other opportunities available around. The investor should always compare the stock with its peers. Similarly, when the investor already holds a stock, one should not automatically purchase more of the stock going forward. 'Averaging', as the practice is commonly known, is not rational by itself. It is necessary to look and evaluate at the other opportunities presented at the same time. This is where the function of opportunity cost steps in.

It is important for an investor to judge the reason for the stock's downfall. He should also reevaluate how the stock compares with other alternatives after the fall. The concept of opportunity costs helps in avoiding the mistake of blindly averaging one's previous purchases.


Equitymaster requests your view! Post a comment on "Opportunity cost and investing". Click here!

  

More Views on News

This Number Will Give You an Edge Over Other Traders in the Market (Fast Profits Daily)

Sep 30, 2020

In this video, I'll share with you, a crucial number that I track everyday which gives me trading edge.

Is Mirae Asset Ultra Short Duration Fund a Right Solution for Your Short Term Needs? (Outside View)

Sep 30, 2020

PFN explains about the Mirae Asset Ultra Short Duration Fund.

India's Drone Revolution is a 4x Profit Opportunity (Profit Hunter)

Sep 30, 2020

My research on India's leading defence companies brought me to one major player in drone manufacturing.

The Gold and Silver Bull Market is Not Over (Fast Profits Daily)

Sep 29, 2020

The last few days have been nerve-racking for bullion traders. Stay calm. The bull market still has a long way to go.

Earned Short Term Capital Gains on Shares? Here's What You Need to Know While Filing ITR (Outside View)

Sep 29, 2020

PersonalFN explains CBDT's clarification regarding scrip wise disclosure in ITR in case of short term capital gain.

More Views on News

Most Popular

Top Investing Gurus of India

Investing gurus are the champions of value investing. These are the people who've mastered the art of compounding wealth from...

My Top Stock to Buy in this Market Selloff (Profit Hunter)

Sep 22, 2020

The recent correction offers a great opportunity to buy this high conviction smallcap stock.

Can the Nifty Fall to 10,200? (Fast Profits Daily)

Sep 24, 2020

The Nifty has reached an important support level today. If it breaks then we could see further downside.

What Do the Charts Say About Buying Smallcaps Now? (Fast Profits Daily)

Sep 18, 2020

Everyone seems to be excited about buying smallcaps now...but is it the right thing to do? What do the charts tell us? Find out in this video...

I Believe These Stocks Will Deliver the Most Outsized Returns in 2021 and Beyond (Profit Hunter)

Sep 23, 2020

Rules of the racetrack can help you bag the biggest gainers of the coming decade.

More

Covid-19 Proof
Multibagger Stocks

Covid19 Proof Multibaggers
Get this special report, authored by Equitymaster's top analysts now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Sep 30, 2020 (Close)

MARKET STATS