At this time of the year, I’m often asked what I consider to be the most common financial and planning errors most people make. Over the years, I’ve boiled it down to the seven deadly sins of financial planning. Here’s my list, and some suggestions for how to avoid them.
1. Greed – Don’t spend more than you make
Let’s face it: Too many of us tend to spend what we make, and then some. Even high net worth types often find they run out of money before they run out of month. The first place to start is to try to get a handle on where your money is going. Start with getting a fix on your income. If all else fails – look at your bank statements and pay slips. Document what you find. Next, perhaps again by consulting your bank statements, determine how much debt you paid off over the past year. Mortgages and credit card debt are the most important items to nail down. Now you can document exactly how much you saved, which can be earmarked for long-term investment purposes.
2. Gluttony – Avoid too much of a good thing
Clients have come to me claiming to be ultra-conservative investors. But then they show me account statements with portfolios chock-full of equities – individual stocks, equity mutual funds, and exchange-traded funds. That’s hardly what I’d call “low-risk”! In fact, it’s way too much of a good thing.
It’s a fairly simple matter to fix. Ask yourself what level of loss you can stand in your portfolio over a given length of time. Are you okay with a drop of 10% over three months? Or a year? On a $50,000 portfolio, that’s $5,000. Remember, 10% is how much the stock market loses when it’s going through what’s called a “correction,” as it seems to be doing right now. Are you really, truly comfortable losing that $5,000 in a short period of time? Maybe not!
Creating an honest risk profile will help you rebalance your portfolio in the New Year to just the right mix of safety, income, and growth assets that will truly meet your needs – and let you sleep nights.
3. Lust – When you absolutely, positively have to have it
This very common mistake has been the undoing of many an investor. When I ask new clients why they had made a certain investment that now languishes in loss, they will frequently tell me that they “researched” it and saw that it had recently gone up in price. They simply had to have it!
Investing solely on the basis of great-looking short-term past performance of an asset doesn’t work. In fact, it can actually magnify subsequent losses if the investment has already been gaining steadily. Such investments very often wind up in the media spotlight at the moment of their peak performance. They attract a lot of media and retail investor attention. By then, however, the smart money has already left, and the investment (a high-flying company, or a hot commodity like gold, for example) is ripe for a steep slide. Remember, past performance does not guarantee future results. Compare the return on the “hot” investment that’s caught your eye to a suitable benchmark over the longer term. You’ll often find that past performance doesn’t even guarantee good past performance let alone future results.
4. Envy – But everyone else is doing better!
This is also among the top three most common investment errors. It’s also a sure-fire wealth destroyer. It often seems as if you’re perpetually behind the curve. Colleagues, friends and acquaintances, your barber or hair dresser, and all those anonymous braggarts in the Twitterverse seem to be raking it in with great market calls and investment decisions. As a result, you’re tempted to put everything you’ve got into over-the-counter junior Dryhole Well Services in Saskatchewan, just like your apparently successful neighbor, Fred. Don’t fall for it! Remember, people never brag about their failures, and there are plenty of those, probably more than there are successes.
Financial markets often act like a herd, as investors stampede into or out of individual investments, sectors, asset classes, and entire markets at the same time. In fact, “the market” is nothing more than the combined actions of millions of individual investors. If you sell because the market is declining, you’re just following a herd mentality. And often, the herd runs right over the edge of a cliff.
Define your financial objectives and develop a disciplined portfolio allocation plan that takes into account your tolerance for risk. And then stick with it!
5. Sloth – Don’t put it off!
Many people don’t believe they have enough money to set up a financial plan. After all, isn’t financial planning only for the “rich and famous”? Far from it. Indeed, you may not require a really comprehensive plan until you have accumulated some assets. But if you have a good job, perhaps a home and a growing family, and some money set aside in a nest-egg (through your employer perhaps), a planner could help you set reasonable objectives and work out a plan to achieve those objectives.
6. Wrath – Don’t get mad, get even
Markets go through periods of volatility, and we are in one such period now. The problem, always, is that no one knows precisely whether what’s going on now is in fact a “correction,” the beginning of a “bear market,” or a temporary momentum-driven market triggered by a shift in investor sentiment.
The remedy for volatile market moods is not anger or panic. The best thing to do is to stick to your investment plan – if you have one. The silver lining can be found only if you stay invested in a well-diversified portfolio. Fear is the impetus for bad investment decisions. If you have made a well-considered asset allocation, made solid individual investment choices, and have done your research – whether fundamental, technical, or quantitative – and your investment objectives remain intact, then ride out the volatility. If you have a cash reserve, be prepared to snap up bargains when they appear, especially in the Canadian energy and financial sectors.
7. Pride – Know your limitations
In the litany of investment error, this has to be near the top of the list, if not in the number one spot. Many investors, especially the do-it-yourself variety, have an unfounded confidence in their ability to buy an investment at precisely the right time and sell at precisely the right time to maximize profit and portfolio performance. In practice, this is almost impossible to achieve consistently.
As a younger investor, don’t try to be something you’re not. Most of us tend to overestimate our capacity to deal with risk, investment volatility, and market losses, especially when we’re younger. Always be realistic about your own tolerance for risk. If you’re having trouble establishing what kind of investor you really are, consult a qualified financial planner to help get you on the right path.