Opportunity cost occurs in almost every facet of life. It is inevitable.
In investment domain, opting for an investment asset (A) over another asset (B) means not getting any money from that other asset (B). It is a missed opportunity.
Quantifying the Opportunity Cost (OC)
Opportunity Cost is not the same for every single Investor, depending on their circumstances.
For instance, Steven (a sophisticated Investor) and Tony (a conservative Investor) have some money to invest.
When the Opportunity Cost (OC) becomes a Real Cost
If both Steven and Tony achieve returns from the Stock Market higher than their respective OC, then OC is not an issue.
However, if say Steven achieves only 8% return from the Stock Market, then his OC is realized as he missed out on the additional 2% achievable from the Bond Market.
Is Opportunity Cost (OC) a Bad Thing?
Some might say OC puts unnecessary pressure on Investors. More risky bets might be taken subsequently to maximise returns.
Yet, an experienced Investor might argue that identifying and quantifying OC is a necessity. It sets the floor (minimum) return on the capital deployment at an acceptable risk.
Does the Opportunity Cost (OC) Apply to Stock Picking?
For Investors, OC is not so much important when it comes to picking stocks to keep for long term.
For Traders, identifying OC is important. If a [owned] stock is moving sideways while other [not owned] stocks are heading up, the Trader may consider his / her OC as the potential return from those other stocks.
On a final note, be mindful that investing is meant to give peace of mind while doing other ‘productive’ and ‘enjoyable’ things, NOT continuously thinking about OC every single minute.
Disclaimer: NOT FINANCIAL / INVESTMENT ADVICE. This article is of writer’s personal opinion. Any information contained here is for education and informational purpose only. Readers should seek other sources or professional advice for further clarification where deemed necessary.