An Investing Fundamental You Should Never Forget
It’s easy to lose sight after months or indeed years of trading the basic ground rules that separate sustainable and long term benefits out from potential short term catastrophes. But there is fit one often forgotten principle that we may well implicitly think of, but more explicit thought needs to be
This ‘investing fundamental’ is the theory of opportunity cost. It’s central to the field of economics, and essentially it’s the cost of not doing Y when you do X. In other words, the opportunity cost of an action is the cost of not doing a range of other actions, all of which might potentially offer more rewards.
Say you only have $10,000 to invest, and you choose to invest it all in a relatively secure bank savings account that gives a guaranteed 4% interest rate a year. On the surface, this seems like a great deal; you’re going to be earning $400 a year on it (not including inflation here). But there’s the hidden opportunity cost of not investing this $10,000 elsewhere.
For example, you might have the opportunity to invest through a means that offers a higher ROI (return on investment) denied because you have opted for the safe bank. By simply failing to acknowledge that every action you take has an opportunity cost attached to it, you could miss out on better investment opportunities.
One way to acknowledge whether an investment decision is the best decision you can make is to recognize the plethora of alternatives to your choice. By coming to terms with the wide choice you have, you should be able to assign advantages and disadvantages with all, and this will most usually concern the level of risk involved and whether or not you are want to take that risk.
