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What is the Opportunity Cost of Retirement?

Aug 21, 2015

In this issue:
» Commodity prices bottoming out?
» Innovation and patents fuel India's textile dreams
» Roundup on markets
» ..and more!


00:00
Dear Readers,

As proponents of value investing, we always tell you keep your long term return objectives in mind. This is not just to safeguard your wealth in stocks. But also to ensure that your financial assets are optimally allocated. So that it ultimately culminates into a secure financial future.

In this special edition of The 5 Minute Wrapup we have Anisa Virji writing for us on the Opportunity Cost of Retirement. Anisa as you know is the Managing Editor of Common Sense Living.

In this column, Anisa rightly points out why the risk of not prioritizing and planning for your retirement is too high. She writes, "If you envision and plan your retirement with your opportunity costs in mind, rest assured that your golden years will be, well, golden."

Happy reading!
Tanushree Banerjee

********************************

When I took my first economics class at university, this quote by Gregory Mankiw, a professor of economics at Harvard University and a former chairman to the Council of Economic Advisors, really got me thinking...

"To get one thing that we like, we usually have to give up another thing that we like."

Suddenly, I saw this principle of 'opportunity costs' crop up every time I had to make a major decision in my life.

Opportunity cost is defined as what you give up by making one decision in favour of another.

Say you were choosing between pursuing a career in medicine versus a career in photography.

If you chose medicine, you would give up many years of your life to get trained but would have a financially stable career.

As a photographer, you could start working right away but would be faced with financial and professional uncertainty.

As you can see, the decision is often between time and money -- how much money or time you would give up by choosing one over the other.

But there is one more aspect involved in opportunity cost, and that is your personal values.

You could choose a career in medicine - because you believe it is a noble profession and you would save lives - at the cost of having your passion as a career.

Or, you could choose photography - because it is a passion and you see it as a way of connecting to people and being happy - at the cost of a profession that saves lives.

Every time you make a decision, you lose the chance to do something else, and that is your opportunity cost.

You face this every day. Should I stay an extra hour at work at the cost of seeing my child before she sleeps? Or should I go home and spend that hour with her at the cost of meeting my deadline?

Using this concept of opportunity costs to make decisions helps you prioritise what is most important to you - it reveals your values.

You can use opportunity cost analysis as a tool to assess your current versus future life as well.

So, fast forward several years to your retired life to consider this scenario...

You are retired from your full time job, and this is what it looks like...

You're living a leisurely life. Reading all the books you couldn't during your work life. Spending time with your partner, traveling to new places, exploring new hobbies, or just being at home. Writing a book, consulting, teaching, spending time with your grandkids, volunteering with an NGO.

You could choose to work part time doing the same thing you did before. You could choose to work for yourself - starting a business or consultancy. You could make your own hours and enjoy flexibility. You would have the financial security of an income. Your physical and mental health would (according to some studies) benefit from the regular work. You would have growing wealth and the peace of mind that comes with it.

But to reach that idyllic retirement scenario, you have to trade something you like today. Instead of living a lavish lifestyle, you might have to trim your expenses now, spending sensibly, working hard and investing wisely to prepare for that dream future.

On the other hand, if you choose a lifestyle today that doesn't allow you to invest for tomorrow you might end up living like this scenario...

You have to keep working in retirement to support yourself and your partner...

You haven't saved up and invested enough of a retirement corpus to feel financially confident, so you have to keep working to support yourself. You might live in worry of an illness you can't afford, or of running out of retirement funds before your time is up.

You still feel shackled by your employer and are living paycheck-to-paycheck. You don't have the freedom to travel the world, go live with family in other places for long periods, or even write that book you have been holding inside you all your life... You are worried you will have nothing left to leave for your children when you are gone.

So what do you choose: Live well now, and live well later... Or live lavishly now, but die poor?

So let's put it more starkly: When your life ends, do you want to, like our beloved leader Dr. APJ Abdul Kalam, be doing something you love - standing up at a podium at the age of 83, passing on your wisdom to the next generation?

Or do you want to be chained to a desk worried about making ends meet?

As the brilliant poet Tennessee Williams says:

'You can be young without money, but you can't be old without money'.

Retirement is your second life - don't use up all your energy in your first life at the cost of your second.

If you envision and plan your retirement with your opportunity costs in mind, rest assured that your golden years will be, well, golden.

In my next letter, I will share with you the seven essential steps for retirement planning.

What steps have you taken to plan your retirement? Let us know your comments or share your views in the Equitymaster Club.

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02:44
 Chart of the day
Talking about long term returns, one sector that has the risk reward ratio heavily skewed towards the latter is commodities. The crash in global commodity prices has been accentuated by the Yuan devaluation. And it seems that metal prices in particular are still searching for a bottom.

Yuan devaluation drags base metal prices lower

How long the rout in commodity prices will continue is anybody's guess. But as we have been writing for a while now, the time is ripe to look for some attractive bargains.

The principle of investing in commodities is staying fully in cash at the top of the cycle and being fully invested at the bottom of it. And the logic behind this principle is almost irrefutable we believe. When commodity prices rise, new capacity comes in to take advantage of it. The excess capacity starts putting pressure on prices. The falling prices in turn put pressure on the debt servicing capability of the players. And companies with the most inefficient cost structure are the worst hit. Eventually the debt gets written off, the capacity starts declining and within few years, the cycle starts again.

Of course, the duration of the swing can certainly not be the same across all cycles. But investors, who do their homework well and have been tracking the industry for years, are able to take advantage of these cycles and thus earn handsome profits in the bargain.

Plus it is not just the commodity stocks that may offer significant risk adjusted upside, but the dividend yields on them too may be mouth watering. The dividends could provide natural hedge against the volatility in the prices of the underlying commodities and stock prices.

03:35
The increasing activity on the R&D front by Indian pharma companies stands to good reason. And now this trend is gaining importance in the textile space too. And it's not just the R&D, but patents filings too are playing quite an important role. Since the patents offer longevity to their innovations, many Indian textile manufacturers are increasing their focus and resources towards this area. And this is particularly true when we talk about the global exporters.

Undoubtedly, these developments are positive for the growth and profitability of these companies. However, such higher spending can also impact the financials of the company. You would recollect Rahul Shah discussing about the difficulties in the textile business in a recent edition of The 5 Minute Wrapup. The fact that the return ratio profile of these companies has been quite poor over several years is the biggest worry. To add to that, owing to capital intensive nature of the business most of the companies are highly leveraged. While, it will be unfair to paint all companies in the sector with the same brush, investors should thoroughly check the financials and wealth creation abilities of such companies.

04:45
The Indian indices are trading weak on the back of negative cues across global markets. At the time of writing, the BSE-Sensex was trading lower by around 330 points, while NSE-Nifty was down by about 100 points. Both the S&P BSE Midcap and BSE-Smallcap S&P BSE Smallcap indices were also trading weak, down 1% each. Pharma and IT stocks, however, managed to buck the trend.

04:55
 Today's investing mantra
"There are all kinds of businesses that Charlie and I don't understand, but that doesn't cause us to stay up at night. It just means we go on to the next one, and that's what the individual investor should do." - Warren Buffett .

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Anisa Virji.

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2 Responses to "What is the Opportunity Cost of Retirement?"

Biren Shah

Aug 22, 2015

I had been lucky enough that a good friend of my and CFP by profession had an appetite like my for savings and planning and had been a good guide to me and started investing from the age of 35 years (when really I had disposable income above my house hold expenses)
Since, direct exposure through investing in stocks directly without proper knowledge of valuations, bottom-up and timing of investing and knowing though equity is the only asset class that could make me meet the ends by beating inflation.
Savings required to meet future expenses for kids education, marriages, retirement corpus, the today saving per month was derived considering future value of future expenses at today's cost and accounting inflation.
Having said that I had starting with investing in Mutual funds with SIP @ 50% of my monthly on hand salary before 2 years.
Now, having end up with some more disposable income on hand want to have a direct exposure in stock market to even benefit on a big way and hence had subscribed for your several services.
Today at 40, I am sure with your valued services and planning I would be able to retire at a early age being wealthy.

Like 

Nidige Kumar

Aug 21, 2015

This article just hits nail on the head. Fantastic indeed. Very well articulated with pleasant and loaded words. Thanks. For many, walking the talk could be very challenging, but there is no choice.

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Equitymaster requests your view! Post a comment on "What is the Opportunity Cost of Retirement?". Click here!
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