Is an opportunity cost a real cost? That’s the question I have been pondering.
I was deciding whether to buy an air ticket a few weeks ago. I saw a good price when I did the search in the morning. I was at work at that time and I decided to make the purchase that evening. When I searched again in the evening, the good fare was gone. The price had gone up by $70. I paid $70 more than I could have.
According to Wikipedia, an opportunity cost is "the next-best choice available to someone who has picked between several mutually exclusive choices." The opportunity cost of waiting until the evening is locking in the low fare right then and there. Its economic value turned out to be $70. This example shows an opportunity cost is every bit real. It cost me real money out of pocket.
In the world of investing, opportunity cost is present at all times. The opportunity cost of investing in bonds is investing in stocks that turn out better, or vice versa. The opportunity cost of investing today is investing on a different day when the price is lower. The opportunity cost of holding on to an investment is selling it before the price goes down.
When an investor has an investment that lost value but the investor is still holding it, the investor is said to have had a "paper loss." There’s a saying "You don’t lose until you sell." Is that right? Is a paper loss not real? Sometimes the investment does recover. When it does, it’s as if the paper loss never happened.
As we’ve seen a paper loss is an opportunity cost and an opportunity cost is every bit real, it follows that a paper loss is indeed a real cost. I believe there is no such thing as a paper loss. A loss is a loss. Whether the investment recovers or not has nothing to do with whether the loss existed or not. If it recovers, there was a loss followed by a recovery. If it doesn’t recover, there was a loss and there is no recovery. In either case, there was a loss.
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