When investing there are several different formulas, calculations, and terms that you should be familiar with. But at the root of them is the term “opportunity cost”. It’s not difficult to understand, but it is essential to know when you are learning to invest.
What is Opportunity Cost
Opportunity cost is simply this:
Because you have limited resources, you cannot have two things at the same time.
Example #1
Here is an example.
If you were to get a $50 check from your grandma for your birthday, you cannot buy a $50 game and a $50 pair of pants. You have to choose. And if you choose the game, then the opportunity cost is the pants.
Example #2
You have $500 in extra income each month and you are deciding how to spend it.
You can either spend it on paying down your car loan or investing it into your Roth IRA.
If you choose to pay down your car, the opportunity cost is the money that would have gone into your Roth IRA.
If you choose to invest the money in your Roth IRA, then the opportunity cost is not paying down your car as quickly.
Example #3
You get off of work 2 hours early. You can either spend that time playing with your kids in the back yard or finishing the home repair project you have been working on.
If you choose to play with your kids, then the opportunity cost is the home repair. If you choose to finish the home repair, then the opportunity cost is playing with your kids.
Why Opportunity Cost is Important?
When you are given multiple choices to do something with limited resources, you will have to make a choice. You can either choose Choice A, Choice B, or a combination of the two.
I am not here to tell you what decision to make in any given situation. But it is important to understand that there is a price to be paid with each decision you make.
This includes your finances and money.
You have a limited amount of money and a limited amount of time.
Every decision you make with your money or your time will take away from something else you could have done with that money or time.
Final Thoughts
Make sure that you make intentional decisions. If paying down debt is the most important thing to you, then prioritize that. If saving for retirement is more important to you, then prioritize that.
Make sure that you are prioritizing the things in life that are important to you.
You can do this!
I am here for you!
Until next time!
0 Comments