Avoid These Financial Pitfalls

FOR most people spending money comes easily. But, when it comes to saving and investing money, chances are that most people struggle and this situation leads them into committing financial mistakes. Many times people get so wrong with their financial choices and decisions that their actions tend to not only erode wealth but also infuse a sense of distrust with handling their finances smartly.

With so much at stake when it comes to money, investors cannot afford to keep repeating actions that could have serious negative consequences for their financial goals. The way out to be successful with your finances is by understanding what the mistakes are and how to avoid them. A little education can go a long way in helping you become a better money manager which, in turn, will lead to a more financially productive life. In the following pages we look at the mistakes, with a solution to overcome them.

1. Overspending

This situation is mostly encountered due to lack of a budget. Without a budget, it’s easy to overspend and also borrow to spend. Spending beyond your means easily leads to debt, which often results in a never-ending cycle, costing you a fortune. You should work towards staying off debt or within manageable limits.

Solution: Develop the habit to save money and have a budget. You should also automate your investments so that your temptation to spend is under check. This way you will develop the habit of saving and investing before moving to spending.

2. Lack of Planning

The adage: people don’t plan to fail, they fail to plan holds true for your finances too. If you have written financial goals with clear sums and timeframes to achieve them, the chances of accomplishing them are more.

Solution: Don’t just dream – write out your goals and develop a plan for achieving them.

3. No Emergency Funds

An emergency fund is a must. It bails you out of money problems—hospitalisation, loss of job or just one of those unexpected expense. It is important to have some money readily available to take care of expenses during emergencies.

Solution: You must have about 3-6 months of living expenses saved up that can be used immediately if required.

4. Failure to Start Early

There are major benefits in starting to save and invest. Let’s look at the following example to understand the impact. Suppose you invest Rs 10,000 monthly till the age of 60, assuming 12% annualised returns; if you start at 25 you will accumulate Rs 6.49 crore. The same investment, if it is delayed by 10 years would only grow to Rs 1.89 crore. It is very easy to put off investing for a few years; however, the impact of the delay can be the different between a comfortable retirement and one with challenges and worries.

Solution: Pay yourself first. Set up an automatic monthly deposit into an investment account and discipline yourself to start saving for the future as soon as you start earning income.

If you are like most people, you need to earn a decent rate of return to keep up with inflation and achieve your goals.

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5. Letting your Heart Rule

If you have been tracking the stock market performance in recent months, you must be concerned and worried the way your investments are swinging. Do not exit your investments because you are emotionally unable to cope with the falling markets. At the same time, because the markets start going up, do not start investing in them. The reality is we really don’t know what tomorrow will bring. However, one thing that one should firmly believe is that when investing in equities, one should do so for the long-term.

Solution: Don’t let your heart rule your head by being emotionally attached with your investments. By keeping your emotions in check, you will have a fair idea of how an investment will fare eventually.

6. Not Exploiting Tax Deductions

The Central Board of Direct Taxes (CBDT) has established deductions you can take to reduce your taxable income. Failing to learn about and claim the deductions available to you can cost you each year.

Solution: If you prepare your own tax return, take time to research what expenses you can legally deduct. Likewise, there are tax deductions to be availed on savings and investments. Make sure you maximise the available tax deductions.

7. Overconcern for Taxes

Just as not taking advantage of tax deductions is a mistake, so is being overly concerned about them. Sometimes people put saving taxes ahead of making smart financial decisions. Instead, align your tax savings with financial goals and plans.

Solution: Make sure your financial decisions make sense in the long-term rather than providing only short-term tax savings.

8. Undermining Risks

Risk is an integral part of investments. Risk with regard to investments not only refers to the chance of losing one’s capital, but also the probability of getting less than expected returns from an investment. The lesson for you is that when investing, risks are unavoidable. However, risk can be managed to suit your profile and investment objectives.

Solution: When it comes to investments, risk has two connotations—the risk with the financial instruments and your own perception to risk. For instance, at a younger age, investors will be more risk-taking than when they get old.

Leaving your family with insufficient resources upon your death is a tragic mistake. With the low cost of term-life insurance these days, do make it a point to be adequately insured.

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9. Investing Conservatively

Many people make the mistake of playing it too safe when investing, especially when it comes to their retirement. You need to earn a decent rate of return to keep up with inflation and achieve your goals. Without equities in your portfolio, you will likely not keep pace with inflation. If you don’t keep pace with inflation, your purchasing power will decrease over time. As a result, you will either have to continually reduce your living expenses, or risk running out of money before you die.

Solution: Have some money in growth investments such as stock mutual funds at all ages.

10. Credit Card Debt

Not paying off credit cards in full each month is a very common and costly mistake. Paying interest as a result of not paying off credit card balances each month makes the price of the charged items more expensive. If you look at the illustration in credit card statement which details out the charges and interest on late payment, you would be able to arrive at the near endless repayment cycle because of minimum repayment on card dues.

Solution: If you can’t pay off your credit cards in full each month, stop using them. If you want a card for convenience sake, use a debit card.

11. Underinsurance

Chances of life insurance being among the first financial instrument that one opts for are high. However, it is unlikely that one is adequately insured. Yes, the amount of life insurance that one needs is dynamic and changes every few years depending on one’s stage in life and finances.

Solution: Use among the many online tools available to arrive at your life insurance needs and go in for a pure risk term insurance policy.

12. Considering Life Insurance an Investment

Life insurers and their agents would like you to believe that purchasing life insurance is a good investment. While life insurance is a valuable financial tool and essential protection for most of us, it is not one of the best of investment instruments.

Solution: Keep insurance and investments separate and don’t be blindly guided by the tax savings that insurance policies offer.

13. Not Planning for Healthcare

People underestimate how much healthcare will cost them during their retirement years. Many people do not take medical insurance at all or assume the one that has been issued by the employer is adequate for them. This is a very costly mistake.

Solution: Look for a policy during the healthy period of your life because most insurers tend to limit the scope of insurance cover if you are found unhealthy or offer it at exorbitant costs.

14. Chasing the Past

Selecting investments based on short-term or recent performance often leads to inferior returns. Fund performance changes each day with changing NAVs and performance is led by market dynamics. Moreover, all assets classes move up and down randomly over time.

Solution: Don’t invest by looking at recent performance alone. Instead, develop an effective asset allocation strategy; look for investments that have a proven track record over both down and up cycles of the stock markets.

Don’t attempt to outperform the market through stock picking and market timing; instead capture market returns with a long-term, buy and hold strategy.

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15. Investing on ‘Hot Tips’

People at times invest a lot of money based upon tips from friends or sources without doing any research or evaluation of their own. This could lead to money being bet on the wrong horse or worse—wrong financial instrument.

Solution: Whether a tip comes from a friend or family member, do your own research before investing.

16. Trying to Time the Market

Trying to time the market can be devastating to your long-term investment performance. According to several studies, majority of big stock market gains and declines are concentrated in just a few trading days each year. Missing only a few days can have a dramatic impact on returns. As Warren Buffet said, “be fearful when people are greedy and be greedy when people are fearful.” Don’t make your investing decisions based on the news of the day.

Solution: Buy and hold a properly diversified portfolio of mutual funds and follow a strategic asset allocation plan matched to your risk tolerance, and filter out the noise of whatever else is happening in the market.

17. Panicking During Corrections

The response of an average investor is to start selling their investments during market downturn thinking their money is lost forever, whereas smart investors know how to hold their investments in a volatile market and stay invested over a full market cycle.

Solution: As long as your investment time frame remains the same and the instrument in which you are investing has not changed drastically in its investment approach, you have little reason to worry. Remember; short-term market movement should not impact your long-term investment decisions.

18. Scant Pension Contributions

Even if your employer does not offer you the NPS option, opt for one if you have 15-20 years or more of working life. Do participate in the EPF by keeping track of developments. There are flexible investment options that are being introduced which are favourable in the long run.

Solution: Participate in your employers’ pension programmes and also opt for one on your own. There are tax benefits that you could claim and in the long run these investments can significantly boost your retirement corpus.

19. Ignoring Credit Score

Although borrowing has become very easy these days, knowing your credit score will help you get a loan at a competent rate. A credit score is a number assigned to a person that indicates to lenders their capacity to repay a loan.

Solution: Make a habit of regularly requesting a free credit report from any of the credit rating agencies, as they are required to provide you with a free report once a year. Check the report thoroughly and make sure any mistakes are corrected. To improve your credit report and credit score, make sure you always pay your credit card bills on time.

20. Paying Late Fee

It’s common for people to delay payments on their credit card dues and at times even on utility bills such as mobile, school fee or electricity bills. Late fees not only cost a lot of money, it can also negatively affect your credit score.

Solution: To help you avoid paying late fees, automate bill payment well before the due date with auto debit.

21. Procrastinating Tax Saving

People often wait until February- March each year to contribute towards their tax savings investments. Last minute decision on deploying money could lead to wrong choice of instruments. Likewise, you lose the benefit of compounding which you would gain from if you work on your tax planning earlier in the year.

Solution: Ascertain the sum you need to allocate towards tax savings besides any automatic mandatory contributions. Now that you know how much you need to deploy, do so at the beginning of the year. If you can’t afford to make the entire annual contribution at the beginning of the year, try to stagger the sum through the year.

22. Not Rebalancing Investments

A properly diversified investment portfolio should have multiple asset classes which should be rebalanced. Rebalancing is the act of selling asset classes that have gone up and buying asset classes that have gone down, so you maintain your original target allocation percentages.

Solution: Figure out the asset allocation that is appropriate for you based on your goals and risk tolerance. Rebalance your portfolio back to its target allocation at least once a year.

23. Not Consolidating Accounts

People tend to have multiple bank and investment accounts scattered all over the place. At times, one is paying minimum maintenance fee on them without realising it. Likewise, there are several disadvantages of having duplicate investments and accounts, especially when it comes to having a consolidated view on one’s finances— savings and investments.

Solution: Simplify your life and reduce costs by consolidating the investment accounts you can and follow the same with bank accounts.

24. Not Updating Nominees

It is important that you update nominee and beneficiary details with your financial holdings. If not checked in time, you could land up paying benefits to someone else instead of your near and dear ones.

Solution: Make note of nominations that you make and change them whenever there are changing circumstances in life such as birth of a child, marriage, divorce, old age.

25. Not Creating a Will

An unfortunate death without a will could cause complications in distributing one’s assets amongst the inheritors in a manner that is contrary to one’s intentions. Remember, there is no clear date line for your life and it would be in your interest to ensure that you do not take chances with the life or your dependents.

Solution: No matter what your age, make a will and update it regularly with the passage of time.

(A marketing initiative by Open Avenues)

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