If you’re approaching retirement, you may have started shifting assets over into “safer” alternatives – like fixed interest rate investments – in order to reduce (or eliminate) the impact of stock market volatility. But in doing so, you could actually be adding to a different type of financial risk – opportunity cost.
The national economy is continuing to face an extended period of historically low interest rates as it looks to recover from the 2020 downturn (as well as from some remnants left over from the recession of 2008). Yet, while low rates may be enticing for those who are taking on debt (like a home mortgage), miniscule interest rates can also be detrimental for investors and retirees – particularly because exceptionally low interest rates may not even meet, much less beat inflation. And this can have dire consequences on your future purchasing power.
With that in mind, during times of low interest rates, investors and retirees alike should consider the opportunity risks they are faced with and make adjustments to their portfolios where necessary. Otherwise, you could unknowingly be paying a hefty price with your retirement savings.
Opportunity risk occurs when a better opportunity may present itself after a decision has been made. For instance, if an investor commits funds to a particular investment or financial vehicle, it could prevent the pursuit of better financial opportunities in the future.
As with opportunity cost, this risk concerns the possibility that the returns of a chosen investment are lower than the returns of a forgone investment, causing an investor to miss out on a higher or better-returning investment.
Oftentimes, financial and investment opportunity that offers the potential for high return will also pose the most risk. Just the opposite can also be true in that lower risk – or “safe money” opportunities – tend to force a “tradeoff” of low return.
In some cases, however, even though investors don’t experience losses based on market performance, “safe” investments can actually pose a great deal of risk in other ways, such as:
Ideally, then, investors should look for financial vehicles that can present an opportunity for growth while at the same time reducing the amount of risk they’re taking on.
In addition, on top of the basic risk/reward concept that individual investments can impose, there are other areas where investors could have additional opportunity risk, too. For instance, even if an investment performs well, it is possible that its real return could be diminished or impacted by taxes.
In this case, the same dollar amount of investment placed into a fully taxable, a tax-deferred, and a tax-free account for the same amount of time could end up netting the investor very different results.
As an example, an investor who is in the 35% marginal tax bracket places $100,000 into a fully taxable account, another $100,000 into a tax-deferred account, and a third $100,000 into a tax-free account for 20 years. When taking taxes into consideration here, the results can differ substantially.
Transaction costs should also be considered as an added opportunity risk. These can come in the form of an agent or broker commission and/or any annual management fees that are deducted from the investment on a regular basis. Early withdrawal, or “surrender,” fees can play a big part in opportunity risk, as well.
That is because if funds are withdrawn from the investment within a set period of time, a fee will be incurred. This, in turn, can have an impact on the future benefit of those dollars – even if they are placed into a higher-returning option than the one they are coming out of.
Given that, prior to committing to any type of investment, it is important for investors to thoroughly weigh all of the pros and cons, including any potential opportunity risk.
Any investment or retirement plan should be reviewed on a regular basis. At minimum, this should occur once a year. Although, if you have experienced any type of major life event, a portfolio review should take place even more often.
For instance, on top of pure financial risks like market volatility, low interest rates and inflation, various changes in your life could result in a different set of financial objectives, and in turn, the need to make changes in your portfolio. These life events can include:
With all of that in mind, by not reviewing your plan on a regular basis with a fiduciary – and repositioning assets and allocation, if necessary – there is a good chance that you are “paying” an opportunity cost.
While financial reports and analyses don’t technically show opportunity risk, investors should still factor in this possibility when making decisions – particularly when there are multiple different options to choose from.
Even the most well-constructed financial plans should never be a “set it and forget it” endeavor. The financial markets can change rapidly – and what might have seemed like a good opportunity in the past could actually be dragging down your overall portfolio now.
Alliance America is an insurance and financial services company. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.