The idea that we are missing out is leading to real financial loss

How do we begin to understand light if we have never experienced the dark?  It’s difficult to fully understand a particular thing without also knowing its counterpart or contrast. This is where the concept of Opportunity Cost comes in. It promises to show us the price we are paying; what we are missing out on by making a particular decision. While Opportunity Cost is a valuable thing to consider, it is not the “be all, end all” of making financial decisions. In fact, considering Opportunity Cost has led to real losses for millions. The contrast is real loss financially.

There is a strong implication in that first paragraph that you may be missing out on something better. An opportunity perhaps. Is there a price to pay for thinking you are missing out on some possible future outcome? I would submit that there may be. In our human nature, there is an ingrained sense that causes us to gravitate toward the perception that we are missing out on something. It is one of the main reasons for human progress . As a species, we are always looking to experience something better, but this is also the culprit for much of the financial instability we experience today.

This missing out syndrome can also be known as FOMO. The fear of missing out. Yes, this is a buzzword these days. I would like to frame it this way: there is a real, visceral response that we as humans have when we perceive that we may be missing out.  People go to great lengths to belong, even when it causes them harm. Enter opportunity cost thinking.

We use this thing called Opportunity Cost to help bring contrast to things when we are making decisions. Things like money and investing. If I spend $300 a month dining out then I could be sacrificing the family vacation (opportunity). If I don’t buy more of that stock that just lost 25% of its value then I will miss out on the gains when it recovers. If I buy more now then my overall price is better, right?

By limiting our decision-making framework to just Opportunity Cost, we open ourselves up to self deception. I am so focused on crossing the street that I don’t see the car speeding toward me. Framing things in the context of what you might miss out on causes reactions in your brain to begin to make the case for a certain decisions without regard to other influences. When making decisions from this place, there can be large blind spots. These decisions inevitably lead to pain.  

Let’s take an example. It is the year 2000, and you are 10 years from when you finally get to use the money you have been saving, investing and cultivating to buy your time back.  Then you can do all the things you really want to do, like:

• See family around the country whenever you want
• Hit the beach
• Golf
• Go on trips with your friends
• See the kids or grandkids ofter
• And more
  

Your mantra has been, “I am invested for the long term,” or “I only lose when I sell,” or even “If my investments go down, it is an opportunity to buy more.”  You are focused, proactive and optimistic, as is your advisor.

However, you are so focused on crossing the street (and getting to retirement) that you block out the speeding car headed your way. For those in 2000, setting their sights on retiring in 2010, it was exciting to imagine 2010 until the car came into view in 2008-2009. The focus on opportunity had created a blind spot to an important factor that had entered the equation. Time.

At some point in time, we need to sell those types of  investments to have the income necessary to enjoy the fruit of that growth. Time had entered the equation, and traditional “Buy and Hold” thinking failed us. The loss was not opportunistic. It was, and is, very real.

After all, what is better? Taking the 12% return and cashing out, or staying in for the potential 25% return, only to lose enough to delay or prevent retirement or a financial goal you have set for yourself? Exposing our financial futures to market risk and principle loss for the potential of higher gains (that few of us ever realize) doesn’t really make much sense at all.

Case in point: Let’s talk about John Doe. John worked and saved significant portions of his money over 30 years. He stayed within the same overarching industry and moved up the ranks. He decided to set a retirement date for 2010 back in 2005. John is no stranger to risk because he watched his future money get significantly reduced in 1999-2001. He was in the typical 401K/IRA tax deferred structures invested in “Safer Mutual Funds”.  Like his peers, John believed that risk - that type of risk - was necessary and part of the process. Unfortunately he is still working today at 73 years old.  That is a real loss! Chasing possibilities can come with a price.

There is no real understanding that there is a difference between investing and speculating.  If your principal money is at risk of loss, that is speculating. Investors know that preserving your principal is a prerequisite to being an investor.

Opportunity Cost thinking has proven to be very expensive in the context of perceived investments. When someone begins to frame their investments using opportunity cost, it becomes dangerous.  Human bias plays a very real role in making decisions about our money. Opportunity cost thinking opens the door to potentially harmful outcomes.

Risk cannot be eliminated, but can be properly and effectively controlled. Consider working with those who have a firm understanding of bias as it relates to money management and wealth creation. Not the type of understanding that cites definitions, but one that comes from experience.

We work beside our clients and help bring awareness to their financial picture. Our promise is to clearly understand what is most important to you and deliver results.  Connection begins with a conversation. Connect with us to begin yours.

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