By Brian Frederick
1. Too great a focus on past performance.
It is incredibly dangerous to pick investments based only on prior returns, as what goes down tends to make a comeback and what has done exceedingly well falls back to earth. The things that have the best past performance are the riskiest investments when the market does well and the most conservative in cases where the market is doing poorly. As I write this, stocks have done well in 2013, the last twelve months and the last three years. Do you really believe that the things that have ‘worked’ during that time will continue to work when the stock market inevitably cools off?
2. Too much risk in their investments.
By taking more risk with a portfolio, all it means is that the highs will be higher and the lows will be lower than a more conservative portfolio. When I look at do-it-yourself stock portfolios, I rarely see any exposure to bonds, small U.S. companies, or international companies. The person is only invested in large U.S. companies. Frequently the portfolio will have large positions in just a handful of companies and then a haphazard collection of other things surrounding it.
3. Buying high and selling low.
This is a direct result of focusing on prior performance and taking on too much risk. Rather than focusing on fundamentals and buying low and selling high, emotions in the form of fear and greed kick in leading to buying and selling at the wrong time. Warren Buffett said it the best ‘be fearful when others are greedy and be greedy when other people are fearful.’
4. Too great a focus on what they know.
Famed Fidelity Magellan manager Peter Lynch made buying what you know famous in the 1980s and a result people thought that investing was just a matter of buying stock in companies whose products you knew and liked. What makes a good product doesn’t always make a good investment and vice versa. There is a balance in that as an investor, you want to know what you’re buying, but if you focus too narrowly your portfolio isn’t properly diversified.
5. Improperly structuring insurance coverage.
Most people over-insure small, frequent losses and underinsure infrequent catastrophic losses. This over insurance is most commonly evidenced by things such as setting auto and homeowners deductibles too low, buying extended warrantees on consumer electronics, and opting into things as insuring your smartphone. Conversely, infrequent yet catastrophic events such as premature death, disability that prevents you from working, floods, and earthquakes are underinsured. I’ll write more in depth about this later, but the general rule with insurance is to self-insure as much as you can, and plow those savings into having a good financial foundation so you can absorb the loss if and when it occurs. Buy the right amount of the right type of coverage and make sure you’re paying a fair price for it on things that you do choose to insure.
6. Not having an estate plan.
Yes, I get it – thinking of your own mortality sucks, but you still need to have things in place to take care your loved ones if something happens to you. In working with Generation X clients, there is low mortality, but when a premature death happens people usually don’t have the financial resources to replace their income without some sort of insurance. It’s better to have a plan in place and not need it than to need it and not have it. Also, I don’t recommend using do-it-yourself type programs or services to draft your estate documents. Most attorneys are very price competitive on basic estate planning documents and their experience is invaluable.
7. Buying life insurance as an employee benefit.
While it’s easy and cheap to take life insurance from your employer, this coverage typically goes up in price dramatically once you’re in your mid-40s, doesn’t give you a lower rate if you’re in above average health, and most importantly disappears when you leave your job. While it does take some effort to buy a policy on your own since you have to go through medical underwriting, the benefits are that you can lock in a rate for up to 30 years and have a policy that isn’t contingent on your job. Also, if you are in excellent health and a non-smoker it is possible to save money on the group policies as well.
8. Not accounting for taxes.
When you factor in Social Security/Medicare tax, income tax, property tax, and sales tax it’s easy to see why taxes are the biggest expenditure for most Americans. If you really want to make an impact on building wealth, make sure that you’re addressing the big things first!
9. Not tracking spending.
There is a balance here – you don’t need to know how much you spend down to the last penny but you do need to have a rough idea of where your money is going and where you can cut some fat if the need arises. What I use personally and with clients is the First Step Cash Management System. What I like about First Step is that it doesn’t feel like a budget but it still provides parameters and a framework for making sure that your spending is in line with what you’re ultimately trying to accomplish with your life.
10. Not being clear on goals.
It isn’t difficult to have vague goals such as “I want to retire” or “I want to pay for my children’s college education”. What truly give goals their special powers is having them be clear enough where they help you delay gratification, avoid dumb behaviors and focus on long term rewards. The more specific you can be on the goal the better. For example, on education goals you might focus on things like: Where do you want your children to go to college? Do you want to pay for any graduate degrees? When do you want this goal to happen? Also, write your goals down and have make yourself accountable to someone else for them being achieved!
Brian Frederick is a certified financial planner.