ECONOMICTIMES.COM 15 AUG, 2012, 01.33PM IST,
10 mistakes that can derail your financial life and ways to avoid them
To err is human. But some mistakes can completely derail your financial life. In fact, managing your finances and making smart money decisions can be a challenge and it is inevitable that mistakes will be made.
However, "sometimes even a single financial mistake may be detrimental to your financial goals. In fact, for so many aspects of financial planning, there is no going back, at least without some sort of penalty", according to Harminder Garg, a certified financial planner for Financial Planning Standards Board India.
Let's take a look at some of these mistakes and ways to avoid them:
Mistake #1: Having No Financial Plan
Too many people put financial planning on the backburner until they get older, when panic starts to set in. But having no financial plan or putting off financial planning may be the biggest mistake of all.
"People generally only seek the services of an accountant, for example, when they need to file tax returns. Financial planning is something you can put off easily as there is no requirement for instant gratification - unlike if you have a pain in your body. However, just as putting off visits to a doctor can lead to huge complications, so can delaying an annual check-up with a financial planner.
Therefore, if you want to adequately save for your family and your future or simply retire rich, you first need to get your financial house in order and that can be done only through proper financial planning.
"Financial planning requires thinking through and setting of lifetime financial goals which enable one to determine the appropriate asset allocation required for oneself and one's family. If this asset allocation is followed in a disciplined manner, goals can be achieved without the uncertainties of the market," Lovaii Navlakhi, MD & Chief Financial Planner of the Bangalore-based International Money Matters, says.
Therefore, figure out where you are, where you want to be and put in place a realistic plan for getting there.
Mistake #2: Not Starting Early In Life
Even if some people want to plan for their future, they generally think they need not plan early. Depending upon their individual time frame, thus, they do not like planning for more than three weeks or three months or, rarely, three years in advance.
"Let's imagine that we are kicking off from the centre in a football match. We need to score a goal more than the other team to win. You can't hope that you will defend your goal for 89 minutes and then attack in the last minute and score the winning goal," Navlakhi says.
It is just like planning funds for retirement about a year before the actual retirement date, or even taking a life insurance policy a month before one's death, according to Navlakhi. Having a goal and starting early to meet that goal are absolute musts.
Mistake #3: Not Investing Slowly & Systematically
The problem for many people is that they live month to month and don't develop healthy saving habits until they are in their thirties or forties.
"Contributions to a savings plan should be recognized as the first of your necessary monthly expenses, so that money saved will never be thought of as money that can be spent. Even if you start saving in small amounts now, you can always increase in the future," Navlakhi says.
Mistake #4: Putting All Eggs In One Basket
Another common mistake is non-diversification of portfolio. In this case, a major part of the portfolio is invested in a single or same type of financial instrument which increases risks, resulting in high losses/profits.
"Individuals should, therefore, diversify their portfolio, i.e. all your money should not be invested in the same asset class. Investment portfolios should be diversified in accordance to one's risk appetite," Garg says.
There are two primary reasons to diversify your portfolio - one is to take maximum advantage of the market conditions, and the other is to protect yourself against downturns. The basic concept is to divide your investments among asset classes where returns are inversely proportional to each other.
Mistake #5: Having Unrealistic Expectations
There's nothing wrong with hoping for the 'best' from your investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions.
For instance, lots of stocks have generated more than 50 per cent returns during the bull run in recent years. However, it doesn't mean you should always expect the same kind of return from the stock markets. Similarly, if your property prices more than doubled during 2004-07, it doesn't mean you should expect at least 30 per cent annual return from real estate in the future. The bursting of stock market bubbles is a case in point.
Therefore, when renowned investor Warren Buffett says earning more than 12 per cent in a stock is pure dumb luck and you laugh at it, you're surely in for trouble!
Mistake #6: Not Sticking To The Budget
You are more likely to face financial problems if you have been extravagant in your expenses. However, in a bid to tide over the current crisis and also avoid such crises in the future, you need to adhere to some financial discipline -- making a budget and sticking to it is one of them. However, to do that it is important to keep track of your spends on a day to day basis to ensure your money is going to the right places. If you are already in the habit of making budgets, then you can also readjust your budget to suit your aims.
Always remember that a rupee saved is a rupee earned. Therefore, stick to discretionary budgets so you can handle the uncertainty in non-discretionary expenses.
Mistake #7: Having No Rainy Day Fund
The need for having an emergency fund, particularly keeping some cash at home or in a bank account, has always been emphasised by investment planners.
"Even standard financial principles suggest that you should keep aside cash to cover three to six months of living expenses, which would also be able to cover most emergency expenses," Garg says.
In real life, however, very few people see the importance of keeping an emergency fund in their portfolio. Forget those who can't afford it. It's true even for those who heavily invest in stocks, real estate and other assets - and sometimes pay heavily for their mistake.
Mistake #8: Not Having Adequate Cover
It is pretty evident that an economic recession, a pay cut or higher interest rates on loans would all have much less of a negative impact on your family's financial future than the death of the bread winner of the family. However, few people realize the importance of having sufficient risk cover as most people look at insurance as a no-return investment. Also, as the financial needs of individuals have evolved over time, there is heightened importance of risk protection combined with wealth creation.
"Insurance products can help provide an important protective shield around one's financial goals and retirement savings. They also help in effectively managing a diversity of risks and allows one to enter their retirement years with more confidence," Atul Surana, CFP at Catalyst Financial Planning, says.
Mistake #9: Counting on Tomorrow's Income
Counting on tomorrow's income to spend today is a big mistake which has already been proved by the current crisis. In fact, until the financial meltdown hit us, the spending levels of individuals, especially in the 25-35-year age group, have been almost equal to their income, if not more.
"With easily available loans and credit cards, they were tempted to indulge even without being able to afford the expense. Now with pay cuts and job losses, they are facing the worse. However, even if you keep your job now, the prevalence of pay cuts makes it clear that you can't count on an ever-expanding paycheck to make up for your spending," Navlakhi says.
Therefore, you should avoid counting on tomorrow's income as far as possible.
Mistake #10: Being Guided By Fear & Greed
Many investors have been losing money, particularly in stock markets, due to their inability to control fear and greed. In a bull market, for instance, the lure of quick wealth is difficult to resist. Greed augments when investors hear stories of fabulous returns being made in the stock market in a short period of time.
"This leads them to speculate, buy shares of unknown companies or create heavy positions in the futures segment without really understanding the risks involved," Ashish Kapur, CEO, Invest Shoppe India, says.
Instead of creating wealth, such investors, thus, burn their fingers the moment market sentiment reverses. In a bear market, on the other hand, investors panic and sell their shares at rock bottom prices, thus losing money again.