Every action has a reaction. This physics concepts applies to everything in the world, including finance. If you are creating a financial planner, you are in the process of creating goals for yourself. It also means you’re trying to figure out which actions to take to meet these goals. However, every step you take has an action – which may not always be the one you intended. Before making your final decision, think carefully about what opportunity costs might exist.
But What Are Opportunity Costs?
If you’re taking an online class, the opportunity cost is the inability to network face-to-face. Opportunity costs are advantages you lose out on when you do something. Traditionally, opportunity costs are non-monetary. Sometimes, monetary gains are still included as long as they aren’t wages, salaries, commissions or sale payments.
Opportunity Costs in Financial Planning
In financial planning, opportunity costs may be related to money if the action causing the loss is also related to money. In other words, lost wages are not an opportunity cost to taking a class that will boost your future. However, lost wages can be an opportunity cost to going far away to meet with a stock broker trying to get you invested in stocks or mutual markets. After all, the point of a financial planner is to consider how your finances are going to work out. Thus, opportunities that can lead to a future loss of money need to be carefully considered.
Savings and Debts
One possible monetary opportunity cost is actually interest. A person with debts might consider dipping into their savings account to pay off the debt. After all, the amount spent on the debt’s interest would be greater than the amount lost from the savings account interest, right? Not always. Depending the money available, it might be better to pay off a partial sum of the debt. The new debt interest might be lower than the savings account interest earned and thus the trade-off would become an opportunity cost. The use of financial calculators can help you try out different payments to see how the interest changes. Thankfully, there are many free calculators online for loan, mortgage, and other debt payments; there are also calculator for savings and retirement plans. By using these concurrently, you can determine if it’s worth taking the extra money out.
Risk vs NonRisk
Big payoffs can be very enticing. However, they often come with big opportunity costs. No matter how “safe” a stock might be, there is always some risk involved. An investment in bonds may not have the same chance of a big payoff, but the safety is much greater. Ask yourself how likely your risk is to happen. Is it still worth going through? Risks might not even have to do with direct financial situations. A new job offer with a higher salary might seem ideal, but there can be opportunity costs: travel time, lower insurance benefits, job insecurity from being a new hire. Thorough research and comparison to your old job are necessary to ensure you have the least opportunity cost.