Are you forgetting opportunity costs while investing?

Opportunity cost is the benefit that could have been gained from an alternative use of the same resource.

Are you forgetting opportunity costs while investing?

Sapna Mishra had been waiting to sell her flat in a suburb in Mumbai for more than seven years now. She was waiting for the right price and refused to sell at a lower price.

The right price according to her was Rs 1.5 crore while she kept getting offers of about Rs 1 crore. Incidentally, many others in her area had sold similar flats for Rs 1 crore, but she decided to hold on till she gets a price of Rs 1 crore. Due to the prime location of the flat, she believed that any builder who offers to re-develop the property will pay a good price (of about Rs 1.5 crore) for her flat.

She also thought that since she earns a rental income of about Rs 20,000 after deducting expenses, she is not really incurring any loss by choosing to hold onto the flat.

But experts differ. "Sapna would have made a lot more money if she had sold the flat and invested the same even in simple bank fixed deposits,'' points out PV Subramanyam, chartered accountant and financial advisor.

Currently, her flat of Rs 1 crore, at a monthly rental of Rs 20,000, results in earnings of Rs 2.4 lakh per year. If she had invested the corpus of Rs 1 crore in bank fixed deposits, she could have earned minimum Rs 8 lakh a year (considering a rate of return of 8%). If invested wisely, she could have earned even more.

Sapna's story is not an isolated case. There are many who are in the same boat like her. Many stock market investors get fixated on a particular price or rate of return for their investments. They end up making higher losses as they continue to hang on to a stock because they are waiting for a better price.

"The problem is that such investors fail to calculate the opportunity cost,'' points out Subramanyam.

Opportunity cost is the benefit that could have been gained from an alternative use of the same resource. For instance, you buy shares that give you only a 5% return in a year. Suppose you were to invest the same money in the debt markets where the returns were higher at say 9%. Then the opportunity cost in such a case is your actual returns less the returns that you could have made from the debt market, that is, 5% - 9% = -4%. Thus, the opportunity cost is -4% in this example.

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