We are faced with financial decisions every day, large or small. It is unfortunate when we make financial planning mistakes that could potentially set us back years. But hey, we’re all human! That is why we are writing this weeks blog post on the 5 biggest financial planning mistakes you can make.
Having unrealistic goals
When we start saving and financial planning, we usually have an end goal or multiple goals in mind. These may include; buying a house, savings for our children’s education, saving for retirement, or saving for a new vehicle. In order to stay motivated, we have to set attainable and measurable goals.
Good financial planning goals must have a monetary amount and a timeline (i.e., I want to save $100,000 in 5 years, to buy a house). Specifying a dollar value makes a goal like this measurable. However, if you only make $30,000 a year, a goal to save $100,000 in 5 years is not probable.
Setting goals that are too lofty is a big reason people get discouraged and give up. Even with long term goals (i.e., save $1 million, at age 65) it is best to set additional short term goals. These short term goals should be used as check-ins and can bolster your sense of accomplishment.
Not Contributing Enough
The only way to meet the goals that you have set is to start saving. The earlier you start doing that the better. But are you contributing enough?
Our suggestion is for everyone to max out their allowable TFSA contribution room each year (currently that is $6,000). But if your goal is to save $1 million for retirement, will that be enough saving to achieve that?
That is why it’s important to consult a financial planner. They will be able to calculate and tell you how much you need to contribute, and where you should be contributing, in order to achieve your goals. Maybe you should also be maxing out your RRSP to take advantage of the tax benefit?
You might be under the impression that it doesn’t matter when you start saving as long as you save eventually. Let us look at an example:
Bill starts saving at 25 and saves $5,000 a year for 10 years. At age 35 he stops saving. Instead, he’s going to take a lavish vacation every year until he retires at age 65. Throughout that time he never touches his savings.
Bob starts saving at 35, and saves $5,000 a year for 30 years.
Bill only saved $50,000, compared to Bob’s $150,000. Assuming they both generated a 7% return, who would be further ahead?
When Bill retires he will have roughly $526,000, whereas, Bob will only have about $472,000.
Now if Bill had continued to save that $5,000/year until to age 65, he would have just under $1 million. Those extra 10 years in the beginning and only an extra $50,000 contributed would give Bill well over $500,000 more at retirement compared to Bob.
Not Taking The Appropriate Amount of Risk
Are you taking too much risk, too little risk, or is your risk just right?
We have already talked about goals, and what those should look like. Risk is measuring the reality that the financial planning and investment decisions you make will fail to meet those goals.
There are two components to risk that we should think through. First, the capacity to take risk (can I afford to take the risk?). Second, comfort level when experiencing risk (how much do you worry about your money and financial goals?).
One rule of thumb when it comes to risk is: you can afford to take on more risk when you are younger. This isn’t the case for everyone. The amount of risk you take on also depends on how comfortable you are dealing with it, and your current situation.
We have recently written two previous blog posts on risk: How Risky Are You? and, What’s Life Without a Little Risk?. If after reading both of these, you still have questions about the risk you should be shouldering, contact us. We would love to hear more about your financial situation.
Being Unprepared For Large Unforeseen Financial Expenditures
Loss of income sources and large expenditures don’t happen often but can lead to a great deal of stress. This is amplified when the expenses or loss of employment income is a surprise.
Building up an emergency fund is crucial. We recommended that you have 3-6 months of living expenses saved in cash or near-cash equivalents (term deposits, etc).
If there is ever a negative financial surprise (i.e., loss of income, prolonged sickness, car damage, house repairs) this emergency fund can keep you afloat.
Even for large expenses that aren’t surprising, make sure you gather all the facts. I’m sure we have all heard the term “House Poor”. It refers to a person or couple that has all their money tied up in their mortgage. The majority of their income goes towards monthly payments.
Being house poor is definitely a stressful situation that could have been mitigated with a little number crunching and research. Large financial decisions are never something to rush into. Take a little extra time and make sure you are prepared.
Not Having The Right Amount of Insurance
We have briefly touched on this point before. Insurance is temporary access to a pool of capital under specific circumstances, to cover off large unforeseen financial loss, for a premium paid.
Examples of insurance you may need are: life insurance, disability insurance, mortgage insurance, house insurance, medical insurance, travel insurance, car insurance, and third party liability insurance for business owners and professionals.
Having the right amount of insurance coverage is important for avoiding those unforeseen events that can, and do, cause financial ruin. However, insurance premiums are costly. That being said, you want to make sure you are paying for what’s necessary. Not for something that won’t ever apply to your particular situation.
In our practice we see a couple of extremes quite frequently:
- The desperately under-insured, opening themselves and their loved ones up to exponential financial harm through the shouldering of a large financial burden if something were to happen.
- Individuals who are over-insured; having numerous overlapping insurance policies of varying types and terms. These premiums can be nominal at the beginning but over time they do add up and can get extremely expensive. This can eventually start putting a squeeze on personal cash flow.
Consult your insurance advisors and professionals regularly to ensure you have the appropriate coverage for your particular situation. You want to be covered if something unfortunate does happen. However, you don’t want to pay a premium for coverage that will never be required!
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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy