Financial planning, at its core, can be quite simple. Successful financial planning is often the result of making a series of conscious and intentional decisions over and over again. The longer you make these simple commitments, the greater your likelihood of success.
Unfortunately, this simple definition is complicated by a number of things, ranging from personal behaviors and market performance, to complicated IRS rules and regulations.
Furthermore, successful financial planning can become complicated by mistakes that investors make time and time again. In order to avoid these mistakes, one must first recognize what the mistakes are. Once the common mistakes are identified, we can begin the process of implementing a solution.
Mistake 1 – Only Thinking About Your Financial Goals (or not thinking about them at all)
The Fix – Write Your Goals Down
Having a goal in mind is a great first step to help in achieving financial success.
Writing that goal down is even better.
In fact, simply writing your goal down will put you ahead of nearly 2/3 of the general population (a recent Gallop poll suggests that only 38% of investors have a written financial plan). Perhaps more importantly, 89% of investors with a written financial plan follow it very closely or somewhat closely.
This attentiveness could lead to increased confidence in their financial plan and a possible increased ability to meet their financial goals.
A written plan may often address some of the most important issues faced by an investor. Two topics that commonly rise to the top include retirement planning and investment planning.
Mistake 2 – Set a Year-End Balance Goal
The Fix – Set a Goal that Targets Your Annual Savings
Investors commonly target a year-end balance. For example, a common goal is to have a 401(k) balance of $XXX,XXX (say $500,000) by year end.
Unfortunately, this goal is difficult, if not nearly impossible, for the investor to control.
In the short term, investors have little control over the markets. In any given year, the markets may go up or they may go down. Even long-term investors have little control over precisely how the markets will play out.
Therefore, making a goal subject to short-term market volatility might leave you powerless.
A better goal may be to focus on what you can control, namely how much you are saving. For example, a goal might be to max out your 401(k) this year, or to save $25,000 in a non-IRA account.
These goals are specific, measurable, and more within your control. They are goals that can help remove market volatility from the equation and can help lead to increased long-term financial success.
Mistake 3 – Picking a Retirement Age Out of Thin Air
The Fix – Prepare a Retirement Plan Based on Facts and Figures
The decision to retire is one of the single biggest decisions a person will make in life, yet some retirees approach retirement with little preparation. Instead, they rely on benchmarks, such as a specific age, as their confirmation of retirement readiness.
Unfortunately, relying on a target age (such as 62) doesn’t provide retirement certainty. To be fair, I’m not sure that anything provides retirement certainty.
However, a better retirement confidence may be gained through sound retirement planning. A retirement plan (often the earlier you start the process, the better) should help you understand how much you can spend in retirement, how long the money will last, and should address a variety of “what if’s” that could lead you astray.
Mistake 4 – Not Getting Started Because You’re Already Behind
The Fix – Focus on What You Can Do Now!
One can argue that it’s never the right time to begin a financial plan. Call it inertia, laziness, or fear of the unknown. Call it whatever you will, but not getting started because you’re already behind simply isn’t a good enough answer. The reason being, you may perceive there is always something standing in the way; for example:
In your twenties, you don’t have any income.
In your thirties, you’re just getting started, paying down debt, and buying a house
In your forties, you have a young family with lots of expenses
In your fifties, you’re paying for college.
And in your sixties, well, it may simply be too late!
The good news is there are a lot of reasons to get started. You want to retire someday, right?
Getting started with a financial plan can be easy. If you are a “crawl before you can walk” kind of person, then a first step could be increasing your 401(k) contribution from 0% to 1%. A second option could be to save 50% of your raise. To quote the often overused analogy, “Financial planning is a marathon, not a sprint”. Saving that first 1% is the same as running that first mile.
If you’re a “jump right in” type of person, then financial planning may mean both cutting your expenses and increasing your savings by a certain percentage. Another option may be paying a fee for a CFP® professional to write a plan for you.
Mistake 5 – Expecting Magic or Luck to Fix Your Plan
The Fix – Be Realistic About What Will Happen and What You Can Do
- Doubling your money quickly
- Betting big on a hot stock and making millions
- Hitting the lotto
These events all fall under the category of unlikely to occur. Possible, yes, but unlikely. If you’re lucky enough to hit the jackpot, then reap the benefits. Congrats! However, this is definitely not a good financial planning strategy.
For the majority of us, it’s going to take more than a stroke of luck to make our financial plan a success. A good place to begin is taking a realistic snapshot of what you should expect.
Hypothetically, if you’re looking to spend $100,000 per year from your investments in retirement, and only have $500,000 saved, then you might want to reconsider your plan. To reach this goal, you may need to save $2,000,000 or more (assuming a 5% withdrawal rate, which one could argue is high).
If you’re looking to “catch up” on retirement in your last few years by doubling your money, then you may want to avoid trying to buy a “hot stock.” Concentrated equity could leave you with a major investment loss and is not a sound strategy for success. A better option may be to increase your retirement contributions or focus on working for a few more years.
Mistake 6 – Thinking Short Term
The Fix – Get Out of Your Own Way
I don’t believe that anything good regularly occurs in the short term with investing and financial planning. In fact, the numbers will suggest that the average short-term investor underperforms the markets by almost 5% per .
It’s difficult not to belabor this point, but nearly everything in financial planning is based on the long term:
Compound interest – long term
Investment returns – long term
Substantial savings – long term
Retirement – long term (hopefully, as we all want to live a long time, right?)
In financial planning, there are no get rich quick schemes, no magic bullet, and no scenario that is perfectly protected from everything.
With every decision in financial planning and investing, we exchange one risk for another or one benefit for another.
For example, when we save, we’re giving up instant gratification. We know that we can use this money now to buy something nice, go out to dinner, or buy a new toy.
In lieu of the instant gratification we feel by spending, we choose to save in an effort to afford retirement. Essentially, we are delaying gratification.
Income Tax is another exchange that we can make in financial planning. We can choose to pay our income tax now and contribute to a ROTH IRA. Or, we can defer tax now and contribute to a traditional IRA.
One of the biggest mistakes investors make is not taking the long-term view on these and other topics. It’s easy not to save, and it’s easy not to consider the long-term implication of taxes. However, by making short-sighted decisions, we may be putting ourselves further behind the eight ball than we thought.
Mistake 7 – Going at it Alone
The Fix – Asking for a Second Opinion
Some things in financial planning are easier than others.
It may be easier to open an IRA, buy a mutual fund or stock, or save in a 401(k).It’s not so easy to calculate the best strategy to optimize pre-RMD withdrawals from IRAs and other investment accounts. It’s not so easy to calculate the opportune time to exercise stock options that balance tax and investment goals. It’s not so easy to evaluate the “what if” risks of retirement, such as what if I die early, what if I need long-term care, what if the market tanks, or what if inflation increases?
It’s also not easy to look at our own work with the same clarity as an outsider.
An outsider (in this sense, a CFP®) could be able to rubber stamp your plan, providing a valuable and reassuring seal of approval. Alternatively, they may punch holes in your plan that will allow you the opportunity to address otherwise unforeseen issues that could potentially derail your plan.
Either way, the fees associated with an independent evaluation may be worth it for you.
The Next Steps
By following the above steps, you may be able to avoid the simple mistakes that many investors make. In fact, many of these changes only require a simple change in behavior.
By implementing any 1, 2, or 7 of these changes, you may find yourself in a much better financial situation.
What other financial mistakes have you made? Or which mistakes do you commonly see others making?