In this blog post, we’ll explore the criteria for making wise choices by examining the concept of opportunity cost hidden behind visible profits.

True investing begins only when you understand opportunity cost

When we previously discussed sunk costs, we explained that what you see isn’t the whole story, and that costs already incurred should not be factored into decision-making. The concept we’ll explore this time is similar: “opportunity cost.” Did you know that the numbers we commonly refer to as “returns” can actually have a completely different meaning?
First, let’s revisit the example we discussed earlier. A person preparing to open a café estimated an initial investment of $70,000 and projected earnings of $26,000 over two years. At first glance, the return on investment is about 37%. If we look at this number alone, it seems like a pretty decent result. It’s not bad compared to other investment products either.
But is this really the true return? It’s still insufficient as a criterion for investment decisions. This is because when deciding on an investment, we must consider not only the profit but also what we’ve “given up.”

Calculate the Invisible Cost: ‘Opportunity Cost’

First, where did the $70,000 initial investment come from? For example, let’s assume that money was originally invested in a fund yielding an annual return of 10%. It would generate $7,000 in profit each year, and with compound interest, the profit after two years would amount to approximately $14,700.
If you cashed out this fund to open a café, the potential returns you could have earned would be lost. In other words, starting a café isn’t simply an act of investing $70,000; it’s also a choice to forgo existing investment returns and switch investment avenues.
Furthermore, labor costs and other operating expenses are added during the startup process. There’s an even greater loss: “time.” If you quit a job paying $10,000 a month to start a café, the opportunity cost over two years amounts to $240,000. Adding the $14,700 in fund returns mentioned earlier brings the total opportunity cost to $387,000.
To summarize:

Actual profit from starting the café: $26,000 over two years
Profit foregone by starting the café: Existing investment returns + salary = $387,000

In other words, you’ve paid an opportunity cost far greater than the actual profit.

Don’t Just Look at Returns; Compare ‘Opportunities’

As shown here, when making investment decisions, you shouldn’t base your judgment solely on the rate of return. You must compare it to the maximum return you could have earned by investing the same resources (time, money, effort) elsewhere. Only through this comparison can you truly assess the ‘return,’ and this is the very concept of opportunity cost.
The reason opportunity cost is important in economics is that resources are finite. Making a choice means simultaneously giving up other options, and the option that could have yielded the highest return among those given up is the opportunity cost.
Although we may not realize it, opportunity cost always exists behind every choice. Only those who recognize the cost of their choices can allocate their resources—time, money, and energy—more efficiently.

How to Apply Opportunity Cost to Daily Life

Opportunity cost is not a concept limited solely to investments. It exists in our daily lives as well. For example, the same applies when deciding whether to go see a movie tonight, study for a certification exam, spend time with family, or meet with someone important. Each choice leads to different outcomes.
If you chose to study, you might have earned a certification and secured a better job. If you spent time with your family, your relationships might have deepened, and meeting that important person could have opened up new opportunities. Going to the movies could also have been an enjoyable experience. The key is to make choices while being conscious of what you’ve given up and what you’ve gained.
Time is finite. Once a choice is made, it cannot be undone. “What you choose” determines “what kind of life you will live.”

In Conclusion

We live our lives making choices every day. Whether those choices are big or small, they come with invisible costs and possibilities. Don’t be swayed by simple rates of return or immediate gains; instead, develop a mindset that makes comprehensive judgments, taking into account even the opportunities you’ve given up. That is a wise life strategy that goes beyond mere investment.
From now on, try focusing on the invisible “opportunity cost” rather than the immediate “return.” That is how true returns are calculated.