Opportunity cost
The opportunity cost of an investment is the return you could have got if you'd put your money elsewhere.
The opportunity cost of an investment is the return you could have got if you'd put your money elsewhere.
For example, if I put £1,000 in shares, I give up the chance to invest in government bonds (gilts). Gilts offer a lower but safer return, reflecting the fact that the government is less likely to go bust than a firm. This is the return I sacrifice (the 'opportunity cost') if my shares then fall.
By extension, if I am willing to invest in shares at all, I should expect to make more than I could earn from gilts. This is the 'equity risk premium'. So if a medium-term gilt yields 3%, my expected return on shares might be more like 8%. That's the opportunity cost of not buying gilts (a 3% return) plus a 5% premium.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
-
Higher rates are disappearing – should you fix your savings?
Fixed savings rates have dropped to their lowest levels in over a year. Should you fix your savings now ahead of a potential base rate cut in November?
By Katie Williams Published
-
Nine million people fall victim to financial scams, says Citizens Advice
The charity says that around one in five people across the UK have been caught out by a finance scam in the past year - here is how to protect your money
By Chris Newlands Published