Opportunity Cost – When neighbor is making more money.

  • Post category:The Principles
  • Reading time:11 mins read

In a meeting with Warren Buffett, Jeff Bezos asked, “Your investment thesis is so simple. Why doesn’t everyone just copy you?” Warren Buffett responded to Jeff by saying, “Because nobody wants to get rich slow.”

In my last post, I went seeking my financial goals. I came up with two things. How much do I need for retirement & At what rate do I need to grow my portfolio. At first, I thought I would look only for companies that could give me at least a 12% return, and anything more than that would be a cherry on the top. What I did not realize, It could also be used to limit my downside.

What 12% means, in theory, is my company stock price needs to double every six years (Read – Rule of 72). It made me take a pause and assimilate information in every minute detail. It’s a revelation.

  1. Lot many companies double in 6 years, but they are not always the hottest stock in the hottest sector. I can choose and invest in a wide variety of companies. (Reality Check – It is much more challenging to find those companies than I made it sound)
  2. I can concentrate on businesses with a bright future not because some pundits screamed on TV but because they have a profitable business and new growth potential.
  3. I can easily avoid herd when I am not investing in companies everyone is talking about. A lot of them go up very fast, and most of them come down ever harder. 
  4. I can enjoy Crypto or Wall Street Bets mania from the sidelines rather than being a part of it. Enjoy not because it’s funny, when it is, but it can teach me something I did not know existed.
  5. I can start observing with calmness & start training my mind. In tumultuous times, It will help me to make rational decisions.
  6. This can also limit my downward potentials in tremulous times because I might be far away from the worst stocks.

Doubling money next year will always triumph when the same results are achieved in 6 years. It is typical human nature. Who doesn’t like getting richer quicker? If I follow this approach, I should feel content with my gains which may be lower than the hottest trend. I should keep letting go of the hottest tips. I would need to train my mind not to feel disheartened or jealous when my neighbor or brother-in-law comes barging in my home telling all about how he made hundreds of dollars with the hot tip he shared a couple of months ago. It should not make me feel unenterprising about my investments. I should not feel apprehensive because my goal is not to get richer quicker. It’s going to be a long road.

Because I aim to learn so, I need to evaluate the other side of the coin. I am not denying that many companies can give me the returns I am seeking but in the very long run. What about the opportunity cost? There must be companies who can provide me the returns I seek in the short term. 

Let me explain my current situation with an example from my investments. Last year, I stumbled upon Airport stocks. Those were on sale because of Covid. I was interested in ADP(Aéroports de Paris). On an avg. It’s 24% up since, Not bad because my target is 12%. At the same time, FB, my other stock, was also on sale. It gained more than 100%. No one could have guessed one year back, but it is how it is. Now when I look back, It’s easier to compare in retrospect. I could have invested in FB more. It is easy to conclude. Is this the opportunity cost? Even when this is the textbook definition, we may need to look at it from a different perspective.

Let me do the same exercise with the same stocks but for the future.

Covid is still going strong, and no one can guess the timeframe, and it will keep hurting the Paris Airport business. But stock should come back after covid. Facebook business, on the other hand, is delivering on promises of 20%+ growth. Like last year, I anticipate no significant business interruption in business in the near term. So the Facebook stock price may rise because their revenue and income are increasing in tandem. In the short term, It may very well provide me with better returns, but can I be sure that in 5 years, ADP won’t be a better stock in terms of returns? No, I can’t, because once the covid is over, The revenue of ADP should match what it was in 2019, and the stock price should follow. 

As I found out, It’s easy to look back and calculate opportunity cost. I do not know what the future has in store and can’t weigh different options to calculate the cost. But I know that Opportunity cost exists, so I need to create my definition instead of using the textbook. And this is how I used the personal rate of return I calculated in the last post to come up with my way to look at something.

“Not able to potentially gain 12% from chosen alternative when another alternative did make it.”

I will add all my learning in Category “The Principles.” Just like Ray Dalio, I very much intended to carve out my own investing principles. In my next post, I will start looking at businesses to list all my learnings with examples. Until then, Sayonara.

Disclaimer: Stocks discussed here are only for educational purposes and not a recommendation. Please do your research before investing.

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