Do you go for a walk and clear your mind, or do you visit your grandmother and make her day? (If your grandmother can’t walk, you can’t do both at the same time.)
Or if you’re sitting in a restaurant and you have to choose between the fish and the steak – is the fish healthier, and only in season for a short while? But you’re dying for some meat, and the chips it is served with.
We’re making choices all day long but, as forbes.com quotes the super investor Warren Buffett, you’re not just choosing something. You’re also losing out because you’ve given up a different choice – and that is how you should calculate what you’re losing.
“Opportunity cost” is a well-known term for those who have attended an economic lecture. The official definition according to the same website is “the value of what you lose when you choose from two or more alternatives”. Choose the chips, and you’re compromising your health; choose the veggies and you’re giving up the short-term pleasure of the carbs.
Let’s translate this for investments, or putting your money away for long-term growth and not in a suitcase under your bed. Under your mattress your money won’t grow, plus it will lose value because of inflation. Inflation is the hungry Pac-man we tend to forget about – over time it munches away at the value your money has. That is why so many investment gurus say your growth should beat inflation. If it doesn’t, you will have less, even if it seems on paper that your money has grown.
The same principles go for the new two-pot retirement system. It allows investors to access a little of their retirement money before their retirement date. If you have a crisis, and no other means of paying for it, taking money from your retirement savings seems like a viable option. Especially if you will replace the savings as soon as you are back on your feet again.
But, on the other hand, if you are using retirement money for spending spree, you are foregoing future peace of mind. You’re going to be very cross with yourself when you retire and you didn’t have the discipline to leave your retirement savings alone. It's like never eating vegetables - at some stage your doctor will have to have a word with you.
With two-pot, let’s look at the different opportunity costs:
- Firstly, the money you take out, is gone from your retirement savings.
- Secondly, you pay tax on that amount, so that is not even in your pocket, but it’s gone, too.
- Thirdly, you’re giving up the growth you would have earned on your savings.
- Fourthly, you now have to give up future enjoyment of your money to try and catch up on points one to three.
Here is a more prominent example:
Three people each contributes R1 200 per month to a retirement annuity to add to their savings at work, and they keep investing for 25 years. They increase their contributions by 10% per year during the savings term.
- Cynthia never withdraws.
- Thabile withdraws once, 50% of the savings component, after 15 years.
- Charles withdraws the full savings component every year.
(We round maturity values at the end of the savings term to the nearest 10 000 and income to the nearest 100. We assume inflation of 6% and that each million can buy R6 000 in income per month.)
(*Real value shows how much you would buy with your future savings amount today.)
We don’t have to make the money thing complicated. The principle is simple: Even a little savings put away over a long time will be better for you than trying to save a lot of money in a short space of time. This is because of another simple concept, called compound interest. It sounds complicated, but it means you’re earning growth not only on the capital or basic amount you are investing. You are also earning growth on the growth of that money, and that is when, as if by magic, your growth starts accelerating.
You can think of it as the children’s tale of the tortoise and the hare. The tortoise, taking one step at a time, gets to the finishing line before the rabbit that took his time to get out of the blocks.
Chances are we can all grow a little older than we think. I’d rather let my retirement money tell the tale of the tortoise, than wishing at age 55 that I had started my money race a bit earlier.