Lists the 10 biggest financial mistakes investors make in their over-enthusiasm to make quick bucks
HAVE you lately started falling short of your investment target or having difficulty in meeting your monthly expenses? Or have you been forced to take one credit card to clear the dues of another? If yes, you’ve got some serious financial trouble ahead, which may be because of some simple financial mistakes you must have made in the past.
Surprisingly, not only common but even seasoned investors make financial mistakes, which they sometimes find difficult to rectify. For many aspects of financial planning, there is no going back, at least without some sort of penalty. The good news, however, is that it’s never too late to learn from your own mistakes or those of others. Here are the top 10 financial mistakes people generally make:
1) PUTTING OFF FINANCIAL PLANNING
Undeniably, the biggest mistake that people make is to ignore the value of financial planning. Financial planning, in fact, requires thinking and setting of lifetime financial goals which enable one to determine the appropriate asset allocation required for oneself and one’s family. Without a plan, people tend to try and ‘maximise’ returns in each and every investment and take on more than commensurate risks, thereby endangering the meeting of the goals which ought to have been simple to achieve in the first place. It’s very much like driving at 80 km per hour in a 40-kmph speed limit zone because you just don’t know how far you have to go to your destination. While there is a chance that you may reach there early, there is a possibility that you may not reach there at all.
2) NOT STARTING EARLY IN LIFE
People generally think that they need not plan early. Depending upon their individual time frame, they do not like planning for more than three weeks or three months or, rarely, three years in advance. Let’s imagine that we are kicking off from the centre in the football match. We need to score a goal more than the other team to win. You can’t hope that you will defend your goal for 89 minutes and then attack in the last minute and score the winning goal. According to him, this is just like planning funds for retirement about a year before actual retirement date. Or even taking a life insurance policy a month before one’s death. No need to say that having a goal and starting early to meet that goal are absolute musts.
3) IGNORING THE POWER OF COMPOUNDING
Investors often overlook the power of compounding. After all, the first lesson in even the most basic investment guide is to let the ‘magic of compound interest’ work for you. Compounding investment earnings, in fact, can turn your small investments into a whopping sum after a period of time. Its power is so immense that your investments will multiply 30 times in 30 years, assuming a nominal return of 12% per annum. And that being a one-time investment only. What if you are investing every month or at least a year? No wonder even Albert Einstein called the power of compounding ‘the greatest discovery of all time’, and Benjamin Franklin described it as ‘the eighth wonder of the world’! A majority of investors, however, still believe that big money is made by big money only.
4) LIVING BEYOND ONE’S MEANS
Whoever advised the world to cut its coat according to its cloth was surely not an insane person. After all, people lose more than they ever gain, simply by living large or beyond their means. Lots of people, in fact, generally get seduced by big-debt, big-ticket luxury items, sometimes going all the way into bankruptcy. If you spend money on non priority assets or other things, mostly under the pressure of today’s lifestyles or driven by heavy advertisements, there is something seriously wrong with the way you manage your finances.
5) NO RAINY DAY FUND
The need for having an emergency fund, particularly keeping some cash at home or in a bank account, has always been emphasised by investment planners. Even standard financial principles suggest that you should keep aside cash to cover three to six months of living expenses, which would also be able to cover most emergency expenses. In real life, however, very few people see the importance of keeping an emergency fund in their portfolio. Forget those who can’t afford it. It’s true even for those who heavily invest in stocks, real estate and other assets — and sometimes pay heavily for their mistake.
6) ABILITY TO PAY IS ABILITY TO AFFORD
People start living on borrowed money once they confuse their ability to pay with their ability to afford. And the availability of easy money — particularly plastic money and the growing EMI culture — fuels their dream. So if today it’s a Santro, it must be a Honda City tomorrow, and a BMW the day after. Thus, people get into plastic money’s revolving credit trap as they don’t understand that it provides them just the ability to pay, not the ability to afford. It’s also because they don’t assess their long-term ability to pay before taking readily-available loan. However, paying interest as a result of failure to pay off credit card bills makes the price of the charged items a great deal more expensive, sometimes taking decades to clear the dues.
7) INADEQUATE INSURANCE COVER
Insurance is surely an asset because it works as a safety net in case of an unfortunate event. However, besides having no or inadequate insurance cover, people in today’s scenario are buying insurance as investment which may not be appropriate. Clubbing investment with insurance involves binding oneself to pay big amount of regular insurance premium, leading to a fixed liability. For best cover, individuals should take insurance on the basis of human life value (the quantum of money required by the family in case of death of the bread winner) with the advice of a qualified professional, if required.
8) RELYING ON TIPS
Too much relying on tips or on even educated professionals in a public forum (like TV channels) is another big error that people make. No expert can profess what every individual who is hearing the channel needs to follow. Beware of the glib helper who fills your head with fantasies while he fills his pockets with fees,” warns Warren Buffett, world’s greatest investor. “You should, therefore, never invest on recommendations alone. Instead, always have proper analysis before investing. If you are unable to do that, you can take the help of a qualified financial planner”.
9) PUTTING ALL EGGS IN ONE BASKET
Instead of putting all your eggs in one basket (which means that a major part of the portfolio is invested in a single or same type of financial instrument which increases risks, resulting in high losses/ profits), you should always try to diversify your portfolio as possible. This way you could earn optimum returns with minimum risk — a strategy not commonly followed by investors. Investment portfolio, however, should be diversified in accordance to one’s risk appetite.
10) HAVING UNREALISTIC EXPECTATIONS
There’s nothing wrong with hoping for the ‘best’ from your investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions. For instance, if your property prices more than doubled during 2004-2007, it doesn’t mean that you should expect 30% annual return from real estate in future also. The bursting of stock market bubbles is a case in point. Therefore, when Warren Buffett says that earning more than 12% in stock is pure dumb luck and you laugh at it, you’re surely in for trouble!
HAVE you lately started falling short of your investment target or having difficulty in meeting your monthly expenses? Or have you been forced to take one credit card to clear the dues of another? If yes, you’ve got some serious financial trouble ahead, which may be because of some simple financial mistakes you must have made in the past.
Surprisingly, not only common but even seasoned investors make financial mistakes, which they sometimes find difficult to rectify. For many aspects of financial planning, there is no going back, at least without some sort of penalty. The good news, however, is that it’s never too late to learn from your own mistakes or those of others. Here are the top 10 financial mistakes people generally make:
1) PUTTING OFF FINANCIAL PLANNING
Undeniably, the biggest mistake that people make is to ignore the value of financial planning. Financial planning, in fact, requires thinking and setting of lifetime financial goals which enable one to determine the appropriate asset allocation required for oneself and one’s family. Without a plan, people tend to try and ‘maximise’ returns in each and every investment and take on more than commensurate risks, thereby endangering the meeting of the goals which ought to have been simple to achieve in the first place. It’s very much like driving at 80 km per hour in a 40-kmph speed limit zone because you just don’t know how far you have to go to your destination. While there is a chance that you may reach there early, there is a possibility that you may not reach there at all.
2) NOT STARTING EARLY IN LIFE
People generally think that they need not plan early. Depending upon their individual time frame, they do not like planning for more than three weeks or three months or, rarely, three years in advance. Let’s imagine that we are kicking off from the centre in the football match. We need to score a goal more than the other team to win. You can’t hope that you will defend your goal for 89 minutes and then attack in the last minute and score the winning goal. According to him, this is just like planning funds for retirement about a year before actual retirement date. Or even taking a life insurance policy a month before one’s death. No need to say that having a goal and starting early to meet that goal are absolute musts.
3) IGNORING THE POWER OF COMPOUNDING
Investors often overlook the power of compounding. After all, the first lesson in even the most basic investment guide is to let the ‘magic of compound interest’ work for you. Compounding investment earnings, in fact, can turn your small investments into a whopping sum after a period of time. Its power is so immense that your investments will multiply 30 times in 30 years, assuming a nominal return of 12% per annum. And that being a one-time investment only. What if you are investing every month or at least a year? No wonder even Albert Einstein called the power of compounding ‘the greatest discovery of all time’, and Benjamin Franklin described it as ‘the eighth wonder of the world’! A majority of investors, however, still believe that big money is made by big money only.
4) LIVING BEYOND ONE’S MEANS
Whoever advised the world to cut its coat according to its cloth was surely not an insane person. After all, people lose more than they ever gain, simply by living large or beyond their means. Lots of people, in fact, generally get seduced by big-debt, big-ticket luxury items, sometimes going all the way into bankruptcy. If you spend money on non priority assets or other things, mostly under the pressure of today’s lifestyles or driven by heavy advertisements, there is something seriously wrong with the way you manage your finances.
5) NO RAINY DAY FUND
The need for having an emergency fund, particularly keeping some cash at home or in a bank account, has always been emphasised by investment planners. Even standard financial principles suggest that you should keep aside cash to cover three to six months of living expenses, which would also be able to cover most emergency expenses. In real life, however, very few people see the importance of keeping an emergency fund in their portfolio. Forget those who can’t afford it. It’s true even for those who heavily invest in stocks, real estate and other assets — and sometimes pay heavily for their mistake.
6) ABILITY TO PAY IS ABILITY TO AFFORD
People start living on borrowed money once they confuse their ability to pay with their ability to afford. And the availability of easy money — particularly plastic money and the growing EMI culture — fuels their dream. So if today it’s a Santro, it must be a Honda City tomorrow, and a BMW the day after. Thus, people get into plastic money’s revolving credit trap as they don’t understand that it provides them just the ability to pay, not the ability to afford. It’s also because they don’t assess their long-term ability to pay before taking readily-available loan. However, paying interest as a result of failure to pay off credit card bills makes the price of the charged items a great deal more expensive, sometimes taking decades to clear the dues.
7) INADEQUATE INSURANCE COVER
Insurance is surely an asset because it works as a safety net in case of an unfortunate event. However, besides having no or inadequate insurance cover, people in today’s scenario are buying insurance as investment which may not be appropriate. Clubbing investment with insurance involves binding oneself to pay big amount of regular insurance premium, leading to a fixed liability. For best cover, individuals should take insurance on the basis of human life value (the quantum of money required by the family in case of death of the bread winner) with the advice of a qualified professional, if required.
8) RELYING ON TIPS
Too much relying on tips or on even educated professionals in a public forum (like TV channels) is another big error that people make. No expert can profess what every individual who is hearing the channel needs to follow. Beware of the glib helper who fills your head with fantasies while he fills his pockets with fees,” warns Warren Buffett, world’s greatest investor. “You should, therefore, never invest on recommendations alone. Instead, always have proper analysis before investing. If you are unable to do that, you can take the help of a qualified financial planner”.
9) PUTTING ALL EGGS IN ONE BASKET
Instead of putting all your eggs in one basket (which means that a major part of the portfolio is invested in a single or same type of financial instrument which increases risks, resulting in high losses/ profits), you should always try to diversify your portfolio as possible. This way you could earn optimum returns with minimum risk — a strategy not commonly followed by investors. Investment portfolio, however, should be diversified in accordance to one’s risk appetite.
10) HAVING UNREALISTIC EXPECTATIONS
There’s nothing wrong with hoping for the ‘best’ from your investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions. For instance, if your property prices more than doubled during 2004-2007, it doesn’t mean that you should expect 30% annual return from real estate in future also. The bursting of stock market bubbles is a case in point. Therefore, when Warren Buffett says that earning more than 12% in stock is pure dumb luck and you laugh at it, you’re surely in for trouble!
