Archimedes Finance

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Opportunity cost

Lesson in Course: Investing basics (beginner, 4min )

We experience regret. How can Robert Frost help us make better financial decisions?

Regret is that sad feeling we get when we wish we had made a different decision. When was the last time we were left thinking we "should have, could have, would have?" We were disappointed in the outcome of a decision we made and probably felt like we've missed an opportunity. We'll need to overcome regret to build confidence in our investment decisions.

The Road Not Taken

Robert Frost wrote a famous poem, The Road Not Taken, about how taking the path less traveled made all the difference in his life. In the poem, he describes a familiar situation, standing at a fork in the road and making a choice.

We constantly make decisions between multiple paths. Some decisions are small, like what to order at a restaurant. Others are much larger, like whether to go to college or what investments to make. However, all decisions have an opportunity cost. Opportunity cost is the benefit we could have had if we had made a different choice

When making a decision, we often only think about the cost associated with the choice we made while ignoring the choices we didn't make. Considering the opportunity cost of different options is part of making a better-informed decision.

 

Where paths diverge

Opportunity cost enables us to choose what we expect will give us the best chance to reach our goals. It prevents us from falling into the trap of regret because we knowingly passed up the potential benefits of a different choice ahead of time. This way, we can learn from the mistakes we've made when investing, not regret them.

Deciding which path to take

No matter how hard we try, things don't always go as we expect. It's usually because of something we didn't consider, or we can't control. No regrets either way because it's something we can learn for the next time.

One of the most challenging decisions we inevitably face is when we've made bad investments. It's hard to decide whether to take losses and sell or hang on while the price is dropping.

Top 10 Warren Buffett Quotes To Inspire Your Investment Goals

Warren Buffett, one of the most successful investors, stood at this same fork in May 2020. COVID-19 hit, and the value of airline stocks that he owned plummeted. Does he hang onto them hoping that things will turn around, or does he sell them? The opportunity cost of holding the airline stocks is the return from other possible investments that he could make elsewhere. He decided he was better off selling those stocks. He had to realize losses in the ballpark of $5 billion!!! We can be sure many people weren't too happy about that decision. However, market movements and a few investments he made afterward racked up a $10 billion gain by November 2020.

The video below walks us through a few short examples of what opportunity cost is and how we can think about using it.

Think about what our investment goals are and consider the potential benefits of making a different choice. We aren't trying to come up with every possible choice. The point is to slow us down so we make thoughtful and intentional investment decisions rather than emotional and irrational ones.

Maybe we came into some extra money, and we're thinking about going on a little shopping spree. The cost of buying that new pair of shoes isn't just the money we spent to buy them; we're also giving up all of the potential gains if we had invested it instead.

Let's say we want to invest that money; where do we invest it? If we invest it in a retirement account, it could be many years before we can access it. We give up our ability to spend the money while it's invested for retirement.  

Perhaps we know where to invest it, but we're torn between different types of investments, say high-growth stocks or dividend stocks. If we invest in growth stocks, realize the opportunity cost is the income and returns that we could have generated by making a different investment. Think about how this cost relates to our investment goals. When we've made our decision, be confident and learn from our mistakes.

Glossary

What is opportunity cost?

Opportunity cost is the benefit we could have had if we had made a different choice.

At Archimedes, our goal is to make investment literacy accessible and free for everyone.

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