“For every opportunity you missed, you got something else in return and for anything you got, something else was lost.” – Ralph Waldo Emerson
What Are Opportunity Costs?
Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another. Although these costs may not be directly coming from your accounts, they can still be have a massive impact to your wealth. It may not be possible to completely elliminate them but reducing them can help you reach your maximum financial potential.
Here are some common areas people face opportunity costs.
1. Insurance
It’s important to secure the maximium protection for your assets, income, and life but at the least amount of cost. Evaluating whether you have the right protections and deductibles in place is key to eliminating waste in protecting your home, auto and liability.
For life insurance, term insurance is the cheapest but in the long-run is the costliest since most will never utilize the coverage and will get rid of the policy at a time they are most likely to benefit from it. Not only are the premium payments and what those dollars could have earned are lost, but the tax-free death benefit also is never realized. That would equate to millions of dollars of lost opportunity cost to one’s family that they will never see.
2. Savings
Most would agree it’s important to save money and have funds available to deal with unexpected costs. It’s equally important to have liquidity to take advantage of opportunities that come your way. Most people are saving money in bank accounts, money markets accounts, or even CDs which are earning rates below inflation and are taxable. Maintaining money in these types of accounts is equivalent to losing money as the purchasing power of your dollars is reduced each year. Finding a more efficient place to store your safe money is key to ensure these dollars are working for you.
3. Overpaying in taxes
Nobody likes to tip the government by paying extra taxes that are unnecessary. However, many are doing so based on the typical financial advice. For instance, most advisors would recommend you reinvest your dividends and capital gains back into your investments to take advantage of compounding interest. On the surface this sound good, but doing so causes your taxes to also compound. The increasing tax bill year results in not only a loss but additional opportunity costs since those dollars cannot earn in the future.
4. How you finance your purchases
The need for financing in your life is significant to help you pay for cars, college, vacations, and homes. The typical approach is to secure debt which equates to pulling income from the future to pay for things we want now. This incurs significant opportunity costs since you’re paying your loan back with interest that cannot be used to grow wealth.
Alternatively, you can save the money required and then empty the account to pay for what you want. Although you avoid interest payments, you still incur substantial opportunity costs since your money stops earning forever once you spend the money. With the price of cars and colleges alone requiring substantial funds, the opportunity cost by taking these approaches could be in the hundreds of thousands of dollars.
Finding a strategy to allow your money to never stop compounding interest while leveraging someone else’s money to finance your needs will greatly minimize your opportunity costs and grow your wealth. It just takes being open-minded to strategies which are typically not taught.
For many, the opportunity costs over a lifetime could amount to millions of dollars of lost wealth. Not only would it impact your lifetime but also the generations to come. If you were positioned to lose significant wealth even if your plans worked out, when would you want to find out?
