What Investors Should Consider Before Making Investment Decisions
Opportunity cost is a well-known concept in the financial and economic world, but many know very little about or understand its implications when it comes to making investment choices among multiple assets.
Opportunity cost is the value of what you lose when choosing between two or more alternatives. It is a basic concept for investing and life in general. When investing, opportunity cost can be defined as the amount of money you might not earn by buying one asset instead of another.
In simple terms, opportunity cost versus investment choices basically asks the question of what else an investor could invest their capital in and what is the potential gain lost after choosing an asset to invest their capital in. .
According to Warren Buffet, “The real cost of any purchase is not the real dollar cost. Rather, it’s the opportunity cost, the value of the investment you didn’t make, because you used your funds to buy something else.
To this end, Nairametrics was able to interview some investment professionals to pose the question of what should guide an individual’s opportunity cost before making an investment decision.
The news continues after this announcement
Dr Oladipupo Tijani – Head of Business Advisory, Norrenberger Financial Group
Speaking to Tijani, he said risk and opportunity cost should be heavily considered. He stated, “When making investment decisions, it’s important to consider both risk and opportunity cost. Generally, there is an inverse relationship (when one goes up, the other goes down, and vice versa) between the risk associated with an investment and the associated returns. To determine the opportunity cost of two investment options, it is essential to understand the risk associated with both.
He further stated, “In general finance theory, the higher the risk associated with an investment, the higher the returns it provides. Depending on the situation, it can be difficult to compare the opportunity costs of stocks/stocks with risk-free investments like federal government treasuries. The reason for this is that although there is a huge opportunity cost to choosing Treasuries over stocks, the liquidity and especially the security they offer can guide your preference over stocks.
The news continues after this announcement
“Although it has been argued that holding cash is safer and generally keeps inflation in line with nominal terms, if inflation is accompanied by a rise in short-term interest rates, holding Exclusion of cash can result in huge lost opportunities.
“Year-to-date returns in the Nigerian stock market, for example, illustrate missed financial opportunities, relative to when cash is held. 22.17%, while some large capitalized stocks also reached 99.52% as of July 20, 2022. Treasury bills have generated an average return of 5.7% per year.
Tijani then illustrated by stating, “To put it into perspective, the N100,000 invested in NGX at the start of 2022 would have grown to N122,170 by July 20, 2022. The same N100,000 invested in Treasury Bills would have grown to around N103,250 (on an annualized basis, if you consider the stop rate other than the return). Thus, the opportunity cost for conservative investors who chose to invest the N100,000 in FGN treasury bills at the start of the year would be N18,920 (N122,170 – N103,250). This is without reference to the current trend in overall inflation, or the constant loss of purchasing power that cash suffers over time.
“There is no doubt that the decision to invest is inherently informed by opportunity cost. However, as an investor, assessing the opportunity cost of an investment can be thought-provoking, and the number of opportunities to consider can seem daunting. You don’t want to make the wrong investment decision and suffer losses, after all.”
What to guide the opportunity cost of an investor when making an investment decision, he said, “Funds available. People generally want to achieve high investment returns without worrying too much about risk appetite. With financial considerations to weigh, the key question to ask before making a decision on opportunity cost is what other investment options are available to channel the available funds?Your decision to invest your only available million naira in treasury bills means that you will never get back that specific million naira (all other things being equal by This one million naira money that could have been invested in personal development (e.g. training), bonds, stocks, held in cash or on a new and improved website for your small business, is the opportunity cost of choosing to invest in Treasury Bonds.
“Time. As an investor, never forget that time is an essential commodity. In the realm of opportunity cost, time can be even more invaluable than money. Therefore, when making a decision investment, always consider the time needed (or saved) by choosing a specific investment opportunity.In other words, once a decision is made at some point to invest in certain securities, you will have likely need some time to be able to exit, reinvest and/or explore other investment options, depending on the characteristics of those investments.
“Effort. The more your overconfidence bias leads you to any available investment choice, rather than thoroughly evaluating factors such as the appropriate mix, cost averaging, portfolio balancing and the prevention of the circumstances that lead to fraud, the higher your opportunity costs.
He concluded by stating, “When it comes to investing, overall capacity is limited for everyone. There is only one compromise. Opportunity costs, then, are simply a matter of deciding what trade-offs you can live with.
Temisan Agbajoh – Head of Digital Asset Desk at Kudy Financials
Temisan believes that considering the value of opportunity costs can guide an investor towards more profitable decision making. He stated, “The opportunity cost calculation is FO-CO which is simply the difference between the expected return of the option dropped and the option taken. It doesn’t stop there, you also need to consider your appetite for the risk and the options available.In simpler terms, look at the investment options available to you and calculate the expected returns from each, then find the difference between them to know the alternative dropped. your risk appetite and the risk ratings behind the investments.
“On a scale of 1 to 5, cash in bank is 1 because it is insurance protected and government backed, while 5 is for stocks and digital assets because of their high volatility. Then the last thing to remember is the timing of your investments, you cannot use short term money to make long term investments. Rent money shouldn’t be locked into a 5-year Eurobond.
Temisan concluded by referring to three considerations before making the right investment decisions. They are; Difference in expected return, risk rating of products and personal risk appetite and time, duration of investments.
Opeoluwa Dapo-Thomas, CEO of Perth Partners
Opeoluwa mentioned a few things to consider before making an investment choice. He stated, “It is now common knowledge that there are a variety of asset classes and options in the financial markets. Now, as a potential investor, you will have to give up some investments due to scarcity of funds or rather limited allocation size. So before making a choice, these are all factors to consider – starting with your investment objective, your risk appetite and your investment horizon.
Now, why are you investing? This answer will determine which asset you want to buy. Capital appreciation or dividends? In addition, your risk appetite is important – it determines which asset to give up and, finally, for how long do you invest? If you need to be liquid in the short term, assets that can be liquidated can be prioritized. So, these are the things that investors should consider.