Every financial planning client is unique, with their own financial needs, resources, and concerns. That being said, there are fundamental strategies for smart financial planning and, conversely, common mistakes to avoid. In this chapter, we’ll share some thoughts about some of the most common financial mistakes people make.
Many people have too much of their portfolio invested in essentially the same type of asset, whether it’s in certain stocks (for example, people who have been compensated with shares of stock in the company where they work), asset categories (stocks, bonds, commodities, etc.), specific market sectors (transportation/energy, healthcare, etc.), or even certain geographic regions. Such over-concentrations of assets create the risk that the category or sector in which one is overrepresented could experience a terrible year, or years. Professionals who have studied investment performance over the course of decades believe that smart financial planning requires balancing one’s investments over a broad range of asset categories, sectors, and geographic regions. By doing so — and periodically rebalancing the investment mix based on performance — one can manage the risk of having a catastrophic drop in their portfolio, while hopefully still having a respectable, and fairly consistent, rate of return.
One interesting thing to note is that some people believe a better way to diversify is to have multiple financial advisors working on different parts of their portfolio. The challenge is that even if multiple advisors are providing good recommendations, they might contradict or duplicate each other because they each have an incomplete understanding of your entire financial picture. The overall plan will probably suffer as a result. The upshot is that the investor might be over-concentrated in certain areas and under-concentrated in others — needlessly increasing their risk. If you’re absolutely committed to using more than one advisor, the best approach is to disclose all the financial elements to all parties involved. From the advisor’s perspective, it’s always best to see the entire financial picture before giving advice on any part of it.
Some people assume that only people with substantial wealth need to establish a will. In reality, wills are important, legally binding documents that allow a person to ensure that their estate is distributed according to their wishes — regardless of how valuable it is. A person’s will also allows them to identify who will take care of their minor children, and who will serve as executor to ensure that their wishes are followed. A will can also allow you to protect your heirs by avoiding a lengthy probate process and minimizing estate taxes. Last but not least, a will allows you to specify exactly what legacy you will leave in the form of gifts and donations. If you never establish a will, there will be no guarantee that your wishes will be known, let alone carried out.
If you’ve already secured insurance for yourself and your spouse, that’s good. But for many people, they may not review the insurance beneficiaries they have named for years or even decades. In some cases, that could mean that ex-spouses may be legally entitled to insurance payouts. A related mistake is not adjusting your insurance coverage as your financial situation changes. The bottom line is that neglecting to reassess your insurance coverage and your beneficiaries on a regular basis can result in your wishes not being carried out — including insurance payouts going to people you would not want to receive them.
Another common financial mistake is to focus too much on a certain goal that one loses sight of the bigger picture. For example, a couple might feel so strongly about setting aside funds for their children’s future education that they all but stop saving for their own retirement — and as a result, put their own financial future at risk. A far better approach is to work with a financial advisor, talk about all of one’s needs, and let them create and implement a balanced strategy that attends to each area of need.
For best results, both spouses or partners need to understand and commit to a shared financial strategy. Not only does this ensure that both parties’ needs and hopes are addressed, but it also helps to reinforce the couple’s financial behavior, since both are committed to the long-term goals. It’s much better to come to a consensus on shared goals, and then pursue them together.
This oversight can play out in a number of ways, but perhaps nowhere is a more clear example than the decision to utilize a Roth versus Pre-Tax retirement plan strategy. In a Roth plan, people pay taxes on their invested assets now and allow them to grow tax-free, so they can withdraw during retirement without a tax liability. Conversely, in a Pre-Tax strategy, you avoid paying taxes when you contribute, so the funds grow tax-deferred. Upon withdrawal, you owe taxes according to your tax bracket at the time of withdrawal. While Roth retirement accounts are not necessarily the answer in every case, a financial advisor can advise about whether, when and how much of one’s portfolio could or should be held in Roth accounts — and how to do so. Furthermore, not every advisor is trained to consider the tax implications of all types of financial decisions you may be contemplating. Whether you’re dealing with business and/or individual tax situations, you always want a tax-smart financial advisor on your team.
Of course, no one is born with financial instincts; they need to be learned and adapted to one’s own circumstances. Money is a complex and highly emotional topic, so it’s not a mystery why people make financial mistakes. To engage in truly smart financial planning, you need a professional on your team. The real benefits of working with a good financial advisor are: they can help you avoid costly mistakes, develop a sound, balanced financial plan personalized to you, help you make educated decisions, and then help you stick to your plan throughout your life.