Opportunity Cost

What does this mean to you and how can you use it to make the most out of your finances?

Opportunity cost = ‘The loss of other alternatives when one alternative is chosen’.

The graph demonstrates the principle:

In scenario K the buyer would have plenty of clothes but the cost to that person is that they would have lost the opportunity to buy food.

In scenario A, they have plenty of food but a lot less in the way of clothes. These scenarios can be taken to the extreme with either all clothes or all food, which one is correct?

Impossible to say without more data, but it is a case of striking a balance depending on the individual’s wants and needs, e.g. somewhere between A and K.

lucesco-straight-line-ppc

So how would this relate to your money and investments?

Swap the food for your investment returns and clothes for your attitude to investment risk. If you have no desire to take much or any risk, the returns you are likely to receive will be low or even negative relative to inflation, in this scenario you will have lost the opportunity to gain a potentially higher return in exchange for some risk, this would be your opportunity cost (or loss!).

Equally true, if your attitude towards risk is very high and not tempered with at least some caution, you might end up very successful from this approach, but your opportunity cost is security and you could end with large losses.

returns-v-risk

So what should you do? I would suggest try not to be wholly at either extreme of this line, very much depending on your personal circumstances, choose somewhere that gives you a balance that you are comfortable with. There are other important ways to reduce risk like spreading your investments and diversification, along with careful research and the use of trusted sources.

We are all individuals and we will all position ourselves differently, so take a tailored or ‘bespoke’ approach to your pensions, investments and savings for the best rewards.

Paul Hutchings 
Product Consultant @ Lucesco

The comments and information above represents my general opinion and does not constitute personal financial advice.

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