What are Opportunity Costs? Simply stated, it’s the cost between two choices.
Investors will face many investment choices over their lifetime and in most cases, will not have the necessary facts or knowledge to assess the respective opportunity costs because they don’t know the alternatives. What those costs are today or will be looking forward toward the future, no one knows, but a little history, education, and knowledge can go a long way in assessing alternatives. Consider the following:
- What if you as an investor choose to pick individual stocks as your investment of choice? In 1995, a time when technology really became an integral part of our lives, investors would have had to weigh the opportunity costs of buying IBM, a global technology leader, or Apple, a relatively new technology upstart, or a company that had been named by Fortune Magazine for 6 years in a row as “America’s Most Innovative Company”. As of today, IBM’s up 151%, Apple’s up 1,509% and Enron…it’s out of business.
- What if you as an investor choose to invest in high-cost actively-managed mutual funds designed to “beat the market” versus just owning a boring low-cost passively-managed S&P 500 index fund? You’re convinced by the financial professionals and the industry that these actively-managed funds can’t lose. Here’s what historical facts have taught us. Actively managed mutual funds with their high fees, have underperformed and continue to consistently underperform the S&P 500 index fund over the long-term.
- What if you as an investor choose to invest as most did prior to 1995, by relying on a Buy-and-Hold strategy versus a Market Timing strategy in today’s “New Age of Investment Bubbles”? Since 1995, investors have experienced two extremely painful bubbles that burst, with each one wiping out more than 50% of the value of their portfolio. Facts tell us if a Buy-and-Hold investor had $100,000 invested in stocks in 1995, the value at the bottom of the Housing Bubble was less than their initial investment after 14 years. An investor that chose a simple Market Timing strategy with clearly-defined entry and exit triggers, would have nearly doubled their money.
- What if you as an investor choose to rely on your emotions to make your investment decisions (which the vast majority of investors still do to this day), versus implementing a disciplined strategy in today’s “New Age”? Research from DALBAR, Inc, a highly respected market research firm, shows that those investors which leverage emotions by always chasing what’s “hot” and following the herd, underperformed the S&P 500 index by almost 6%…PER YEAR. Over the past 20 years, this average investor saw returns of 2.29% per year versus returns of 8.21% for an S&P 500 investor.
So why do I mention all the above? Because investment choices have consequences and you, as the CEO of your retirement future, must weigh the opportunity costs of each such choice, wisely.
We at The Self Empowered Investor are committed to teaching investors how to realize their lifetime wealth potential and avoid forfeiting a majority of it to the many intermediaries in the financial services industry.
If you as an investor choose to try to pick stock winners, invest in high-fee actively-managed mutual funds in an attempt to beat the market, depend on a Buy-and-Hold strategy to build long-term wealth, or follow the herd because it feels good or sounds like the right thing to do…history teaches us you will NEVER come close to realizing your lifetime wealth. Those are just the facts!
So what can an investor do to realize their lifetime wealth potential? It’s much simpler than you may think:
- Commit to be your own most-trusted financial advisor; Do Not blindly turn responsibility for your future over to someone else that does not have your best interest at heart, even though they say the words. And never give someone custody of your money. Doing so exposes your money to 100% risk of loss. Investors have and continue to lose their life savings to unscrupulous financial advisors due to greed. Don’t think it can’t happen to you…as that’s what those investing with Bernie Madoff thought.
- Recognize fees matter…significantly; Invest in only low-cost, passively-managed and tax-efficient funds like Exchange Traded Funds (ETFs), Index Funds, and/or Target Date Funds. This will ensure your money is building wealth for your future and not that of someone else.
- Implement a clearly-defined strategy that protects your wealth; Commit to a disciplined strategy with clearly-defined entry and exit triggers/indicators. In today’s “New Age of Investment Bubbles”, protecting your wealth MUST be your #1 priority if you want to realize your lifetime wealth potential. It’s easy to make money during Bull Markets, but the greatest challenge and risk facing investors today, is how to protect their wealth BEFORE the next bubble bursts. Why lose 50% or more of your wealth if you don’t have to?
With knowledge being today’s new currency, it’s critical for investors to understand the opportunity costs of their investment choices. The investment rules that worked two decades ago, are no longer applicable in today’s “New Age of Investment Bubbles”.
The past may not predict the future, but investors can certainly leverage the facts of the past two decades to significantly improve the probabilities for realizing their lifetime wealth potential.