An opportunity cost is an economic term, which in its simplest form, describes the "forgone benefit that would have been derived by an option not chosen."
Understanding the idea of opportunity costs can help you to understand your own financial decision-making and help to make better financial decisions in the future. How? Through being aware of the impacts that the choices you make (and why you make certain choices), can have on your life.
In the below video, Harrison discusses the impact that market volatility can have on your investments. Or if you prefer, keep reading!
As Harrison's video explains, the below example shows the opportunity costs to a Sound Life client who had three choices regarding his Superannuation account when COVID-19 hit in March 2020:
Take out $10,000 of his superannuation (in this case, our client was not in a position where he needed to access this money),
leave the $10,000 in his super account or,
contribute an additional $10,000 into his super
Our client's account grew modestly due to his employer contributions, and from 19 March 2020 to 11 March 2021, there was a 25% increase in market value. Considering these two factors, our clients account on 19 March 2020 sat at $38,000.
Scenario 1: Client takes out $10,000 on 19 March 2020, leaving $28,000
Scenario 2: Client leaves his super account as is, at $38,000. With the 25% increase, by 11 March 2021, the client's super account sits at approximately $51,000.
Scenario 3: Our client contributes $10,000 on 19th March 2020 making his account total $48,000. With the 25% increase, by 11 March 2021, our client's investment would sit at approximately $60,000.
This demonstrates the power of compounding interest and an example of how more money in your investments, creates more money to gain interest on.
The decision our client made was to leave the $10,000 in his super. While he also considered the opportunity an additional $10,000 contribution could provide and potential growth due to the benefits of compounding interest, he weighed up the costs and benefits of each choice and was willing to forego this choice due to uncertain times and to an extent his own risk profile.
Our client's opportunity cost in this example was approximately $9,000, however the opportunity cost could have been $16,000 had he withdrawn $10,000.
During times of market volatility, we act as your backstop, your safety net. Your investments whether inside or outside of your superannuation, will face unpredictable times. We bring calm to help you stay in control and give you peace of mind.
Please note that the information provided on our website is general in nature and does not constitute financial advice so before you make any changes or amendments to your existing circumstances, please talk to a financial planner or your accountant.