10 Common Financial Mistakes to Avoid
August 15, 2013A friend of mine recently sent me this article about how in many competitive areas of life, it makes more sense to focus on preventing bad decisions rather than trying to make good ones. That’s because the advantages of making the good decisions can be largely cancelled out by other people making good decisions. In other words, it’s really hard to beat everyone else by making good decisions and relatively easy to avoid making the bad ones. This is what’s called a “loser’s game.”
The stock market is a great example of this. In his famous book Winning the Loser’s Game, Charles Ellis makes exactly this point. Since every professional investor is trying to uncover value in the stock market, stocks are priced relatively efficiently so it’s incredibly difficult for any investor to outperform the market (which is essentially the collective knowledge of investors as a whole) with any consistency over time. That’s why so few actively managed mutual funds outperform index funds that simply track the market.
The same is true of your financial life as whole. There are two main ways to become financially successful. One is to earn a lot of money either through your job, a business your start, or an investment you make. But all three are fairly rare and difficult to achieve. The second and much easier way is to just not make any of the following common financial mistakes:
1) Spending more than you make. According to our latest research, 32% of employees do not spend less than they make each month. Symptoms of this include depleting savings, growing credit card debt, or worst of all: payday loans. Yes, it can be hard to live within your means but just remember that someone, somewhere is getting by on less income than you are. If they can do it, so can you.
2) Not having sufficient insurance coverage. This is one mistake you don’t want to make. Everyone should have health insurance and with the new health care law, it will be required. If you own a car or home, you need auto and homeowner’s insurance. If you’re a renter, you may want renter’s insurance. If your net worth exceeds your liability insurance, you might want to get an umbrella liability policy. If you have dependents, you may need life insurance to provide for them. Finally, if you have considerable assets, consider long term care insurance
3) Not having an emergency fund. Not everything is covered by insurance. You’ll need some savings to cover your deductibles and to pay your important bills for at least 3-6 months if you’re in between jobs. However, almost half of employees do not have a sufficient emergency fund.
4) Not saving enough for retirement. Only 20% of employees know they’re on track to replace at least 80% of their income in retirement. If you haven’t done so, run a retirement calculator and make sure you’re on track to your retirement goals. The earlier you start saving, the easier it will be.
5) Not maxing the match in your employer’s retirement plan. Make sure you’re not leaving any money on the table.
6) Not taking advantage of tax shelters. Your employer’s retirement plan allows you to set aside money pre-tax and tax-deferred until you take it out. Roth accounts allow you to set aside money after-tax to grow tax-free. If you have an eligible health care plan, you may also be able to contribute to a HSA (health savings account) both pre-tax and tax-free for qualified medical expenses.
7) Having too much in one stock. One of the biggest mistakes I see people make is in having too large a percentage of their portfolio in their company stock. You shouldn’t have more than 10-15% of your portfolio in any single stock, especially if it’s your company’s stock. No matter how great your employer is, you never know what can happen and you don’t want whatever happens to cost you your job and your portfolio at the same time.
8) Not being properly diversified. Only 39% of employees are confident that their investments are allocated properly. Just having many stocks or a mutual fund isn’t enough. You also want to be diversified across many different types of investments like bonds and cash as well. If you’re not sure how to do this, you can take this risk tolerance questionnaire and follow the suggested guidelines.
9) Paying too much in investment fees and other costs. You can’t control what the market does but you do have some control over what you pay to access it. Consider sticking to low cost index funds to minimize management fees, taxes, and trading costs.
10) Not having necessary estate planning documents. This includes a will, health care directive, a durable power of attorney, and up-to-date beneficiary designations. It’s probably the easiest mistake to make because no one like to think about being dead or incapacitated but you’ll want to have these documents before you need because by then, it will be too late.
By avoiding these 10 mistakes, you’ll be well ahead of the majority of the population. While a few of them might take some effort, it’s still a lot easier than significantly boosting your income or getting lucky in the stock market. Sometimes the best way to win, is to not lose.