Rarely do people enjoy thinking about opportunity costs—but factoring those costs into our daily lives is the key to making more meaningful decisions.
In our personal lives, we can relate opportunity cost to the cost of doing one activity over another. Our time is valuable, so how do we make the most out of each moment?
In finance, opportunity cost is measured in choosing one investment over another, or choosing a typical savings account over a whole life policy…or any number of decisions.
This subject can be hard to broach with clients, especially when it comes to the choices they’ve already made. No one wants to be told that they’re wrong. And certainly, no one wants to be told they’re “wasting” their money.
So how do you even begin to discuss opportunity costs?
Start with the Present
Although it can be tempting to look back with a client, look to the future as much as possible. If you show them how much they have already “lost” in opportunity costs, it can be disheartening.
Instead, consider where they want to go and discuss some strategies with them that they can implement NOW. That is the time to bring up opportunity cost—with variables that you and your client can CONTROL.
Control is one of the cornerstones of prosperity, and opportunity cost is a great way to teach your clients that they have control (and how to exercise it). When presented with options, opportunity cost can often reveal the ideal path for your client. Exercising control over their current assets and the future of those assets empowers your clients!
Don’t Hit Them Over the Head
There’s a lot of information out there. It can be easy to overload your client with too much information, and opportunity cost is a concept that can be overwhelming. If you’ve put in the work before you meet (and hopefully you have), you understand your client’s finances pretty well.
Start them out with just one idea—apply the opportunity cost to their mortgage first, the management fees on a qualified plan, or perhaps their term insurance. Don’t bombard them with everything, but focus on what is most important to the client. Once they understand the principle, they’ll be better equipped to apply it to other situations.
Use a Theoretical Example
Using the client’s information isn’t always best, especially if you just want to introduce the concept. Using the client’s numbers can feel discouraging or feel too confrontational. Discussing finance for many is triggering, and as an advisor, you walk a fine line between empowering your client and making them feel judged, hopeless, or any number of things. And we know that you’re reading this because you want to empower your client.
If you just want to introduce the idea, start with a (simple) theoretical application, using the Future Value calculator. Here’s an example:
Say “Shirley” enjoys going to the movies every Friday. It’s been always been a tradition. This tradition costs anywhere from $5-$20, depending on the theatre and whether or not it’s in IMAX. If she always buys a snack, you can add an extra $10-$15. For this example, we’ll say Shirley spends $25 every Friday on her movie excursion. That’s a total of $100 a month.
If you ask the client how much that costs Shirley, they’ll say $1,200 a year. While not incorrect, it doesn’t account for opportunity cost. In short, the opportunity cost is how much Shirley’s money could have grown had it been put to use in a different way: in a savings account, or even a whole life insurance policy.
With a modest increase of 3%, that $1,200 is now $1,217. That’s almost one more movie week. Bump it up to a 10-year time span, and suddenly what should only be $12,000 is just shy of $14,000. That’s almost two extra years’ worth of movies.
Presenting this idea to a client shows them in small terms how important their larger financial decisions are to their financial health. Say instead, Shirley went to the movies twice a month, and put that extra $50 in a savings account? She’s not sacrificing tradition entirely, and by the end of the year, Shirley has the beginnings of a fund for opportunities.
Consider Fees and Taxes
Although it’s a big topic, fees and taxes (like everything else) have an opportunity cost. If your client has a good understanding of what opportunity cost means, and they feel more empowered to take control of their finances, consider discussing fees and taxes. Investments based in the stock market will incur management fees, and they will be subject to tax upon withdrawal. Whole life insurance has the advantage in both regards.
Not only does whole life insurance protect from loss, but has annual returns. There are no management fees, and if you borrow against the policy it is not taxable as income. To go the extra mile, you can calculate the opportunity cost of the taxes and fees applied to an investment. A high ROR can still be outperformed by a whole life policy after fees and taxes, and the opportunity cost is even more eye-opening.
Depending on the client, you may not want to go down this road (per the section above), but it can be important to calculate on your own in order to be of better help. Which leads us to the next point.
Some Work is Better Behind the Scenes
Not everything you do in the calculators needs to appear in your conversation with a client (again: don’t hit them over the head). Doing the work beforehand is CRUCIAL to having a productive meeting—and not for the reasons you might think.
Doing the work gives YOU the clarity to discuss things with your client in the way they learn best. Some clients are visual, or love numbers, so a deep dive into the calculators might be PERFECT. Others are more conceptual, and you better have those concepts mastered! Doing the work gives you the confidence to meet your client’s specific mode of understanding. And if they want to look at the work—you’ve got it all right there.
Opportunity cost is SO important, but the concept even more so than the specific numbers in many cases. If you can provide a clear picture of why it matters, they’ll trust you when it comes time to put strategies into play. If you’re calculating the specific opportunity cost of every decision with the client every time, there is likely a disconnect.
After all of this, opportunity cost may be on the brain for some time to come—and that’s great. Thinking and learning are essential to growing. If you can implement these ideas into your daily routine, you’ll find that you’re more intentional with how you spend your time and your dollars, As a result, you’ll be happier with your life. Your relationships, especially with clients, are built on trust. Leading by example is an excellent way to build trust with your clients—if you live your life joyfully and successfully, they’ll naturally want to learn and do the same.
Take this lesson and use it in your own life and in your business, and watch as things transform. A free trial of our Truth Concepts software is always available, and all calculators include opportunity cost. For more information about the calculators, see here.