7 Common Financial Planning Mistakes To Avoid
A topic I see talked about quite often is the simple path to building and maintaining wealth. You can find thousands of articles / books covering this topic, each with varying perspectives and words of advice (both good & bad).
What always shocks me though, is the general response from folks to the tune of ‘that is all it takes?’, ‘there has to be more to it?’. Said different, people are often surprised at how simple it can be to build substantial wealth over 10,15, 20 year time frames – building and maintaining true wealth is mostly based on only a few guiding principles.
So, in today’s blog we will take this topic from the opposite end, and review 7 commons mistakes I notice that hold individual / families back from building and maintaining wealth.
- Living above one’s means – especially when income increases
The first mistake is as old as time – not living below your means – said different, spending more than you make. In my opinion, this is the fastest way to become illiquid and fall farther and farther behind on your goals.
In my career, I have met with far too many high earning individuals / couples that have nothing to show for it, because they have spent the majority of their income on houses, car, clothes, travel, and set very little aside into investments / rental properties.
This goes hand in hand with increasing your spending as your income rises – which can lead to financial ruin much more rapidly. While it is more than OK to (and you should) enjoy your life as we are all only here for a short time, you do need to set some type of guardrails for yourself to ensure you stay balanced.
If the rise of social media has taught us anything, it is that folks who appear to live a lavish lifestyle - more often than not - have accrued major debt to maintain this lifestyle, and typically do not have actual assets to lean on down the road.
Overall lesson here:
- Spend less than you make
- Automate savings / investments based on your income level / future asset goals
- Put your cash to work, but remain liquid
- Do not give in to lifestyle inflation
- Lack of automation / too much cash at the bank
In my experience, not automating your savings / investments can lead to accumulating too much cash at the bank (earning very little interest) and overspending. Not only does automating contributions make your life simple, as you do not need to remember to contribute, it also allows you to control your spending – think of it as forced savings.
If you are a W-2 employee, you are most likely contributing to your 401k or 403b plan from your paycheck, however, outside of your employer plan you may be considering making contributions to an Individual ROTH IRA, investment account, savings account, etc. If you are self-employed, you need to establish your own retirement plan and systematic contributions.
Simply put, once you have a basic understanding of your net income each month, basic expenses, you can then making decisions regarding contributing the difference between savings and investment accounts. If you like to travel, intend to purchase a car, second home, or other big ticket items in the near future, you can automate savings into a separate account to intentionally save for this expense - rather than paying for it out of cash flow down the road.
This becomes second nature once you establish automations.
- No liquid emergency fund
While we are on the topic of managing your cash flow, it is EXTREMELY important to create a cash reserve / emergency fund that is liquid if you need it. This could be used for an immediate / necessary home repair, unexpected medical expense, car repair / new car, loss of job, disability, etc.
A good rule of thumb is to have 3-6 months of expenses saved. If you are a business owner, this should be more like 9-12 months of personal living expenses set aside in a liquid vehicle – taxable investment account, money market fund, savings account, etc.
The biggest mistake I see here is liquidity – as some view their emergency fund as their ROTH IRA, 401k plan, retirement accounts – which is not always the best option when factoring in taxes, penalties, and the potential growth lost by taking these dollars out of the stock market.
Along these same lines, sometimes folks will plan to pay for these unexpected expenses out of cash flow, which could work, but in some cases they do not account for a potential large decrease in income, or a brief adjustment to their lifestyle if the expense is large enough. Operating this way can lead to creating new debt and long term negative effects on your assets.
- Lack of insurance coverage
As life evolves, you should always be aware of potential risks you are exposing yourself to, and how you can put strategies in place to reduce, and sometimes prevent these risks all together.
In some cases, I find that folks are underinsured in several areas, which exposes their situation to unnecessary risks, especially in a worst-case scenario:
- Premature death
- Disability event
- Car accident
- Damage to their home
- Being sued
Sometimes clients are surprised to learn that we can drastically reduce risk by making slight adjustments to their coverages / policies types:
- Life Insurance
- Disability Insurance
- Home & Auto Insurance
- Liability Protection (Umbrella Policy)
- Business Insurances (if self-employed)
- Lack of estate planning
This is a common shortfall I have noticed across the spectrum – from clients in their early 30s to their late 60s / early 70s. Some put Wills in place when their children were little and never updated them, and others have amassed net worth in the millions of dollars and do not have any estate planning documents in force to efficiently pass this on to the next generation.
A very simple way to disrupt the transfer of your wealth and create family tension along the way is to not have an estate plan established. For young parents, not having guardianship instructions set up in your Will in the case of a premature death can leave your children’s future in the hands of the State you live in. Very scary.
Furthermore, not executing some strategies in this area can expose your assets to unnecessary risks while you are living.
As you consider taking action, it is prudent to address the following:
- Wills
- Medical Directives (healthcare proxies)
- Powers of Attorney (financial powers)
- Guardianship of children if both spouses pass away
- Trust vehicles
- Revocable vs. Irrevocable
- Charitable gifting strategies
- Rental real estate – focusing too much on cash flow vs. appreciation
I do not always intend to pick on social media trends, but younger folks will come in and reference a ‘financial influencer’ they saw online that discussed the benefits of cash flow from rental properties. Mostly citing that it is ‘easy to do’ and folks can make a healthy living off of ‘passive income’.
There is a lot to unpack here that I will not get into during today’s blog, so please reference my prior blog ‘Four Common Tax Planning Mistakes’ for more information.
For today’s purpose, I will say that from working with clients who are seasoned real estate investors - while cash flow can be a benefit in the long run, this is typically outweighed by the appreciation of the property, mortgage principal pay down, and tax benefits (depreciation / operating expenses). Like anything else, real estate is a long-term play, and should not be looked at as a short term ‘get rich quick’ scheme.
Real estate can be a very powerful income and wealth building tool, but you need to understand the basics, and work with a professional well versed in these topics in order to make sure you are operating the right way.
- Not taking advantage of employer benefits
Similar to estate planning, I find that many people do not take full advantage of the benefits offered by their employer.
With open enrollment right around the corner for many W-2 employees, be sure to review the items below, and confirm you are taking full advantage of benefits offered:
- Group Life Insurance Coverage
o Adding additional coverage if debt levels increased – i.e. a new or bigger house was purchased - increase income, child is born, etc.
• Group Disability Insurance Coverage
o Income increases, debt increases, spouse stops working or pursues a different career (starting a business)
• Type of Health Insurance Plan
o If not enrolled in a high deductible health plan (HSA eligible), weigh the pros and cons of doing so
• Flexible Spending Accounts (FSA’s)
• Taking advantage of a Legal Insurance Benefit
The last bullet point is one that many folks do not know about, but it is becoming more common amongst employee benefit packages. Essentially, the employer provides a list of approved estate planning attorneys (in the area) for the employee to choose from. The employee (& spouse) work with the law firm to conduct their estate planning.
Best part is that the benefit usually covers most, if not ALL, of the cost for the legal work. The amount the employee pays per paycheck for this benefit is usually minimal compared to the actual cost of the legal services
To conclude – avoiding these 7 mistakes can assist you in building wealth, flexibility and choice, today and down the road.
Always review your options!!!
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give tax or legal advice.