How to avoid the most common financial mistakes – Part 3 - Episode 14

Today’s episode is the 3rd and final look at the most common financial mistakes I come across when advising clients.  Thanks for your comments and feedback on the previous 2 posts, it seems that many of you have battled with some of these issues yourselves, and there were a few other mistakes that you’ve managed to make that, whilst being proud of them is perhaps not quite right, they are certainly something good for a laugh well after the fact. I’ve got 5 more for you today, so let’s dive in and help you avoid the most common financial mistakes. In episode 9 we looked at Jenny’s story, where her husband suffered pancreatic cancer and was without any personal insurance.  They had looked into obtaining personal insurance, and indeed Jenny had done so, but he took the “I’m tough as nails, it’ll never happen to me” attitude, to the detriment of their family. So the next common financial mistake I see is people not having appropriate personal insurance.  There are 4 types of personal insurance, and I’ve got explanations for what they each do in the Toolkit for this episode, so be sure to go to the financial autonomy web site and download that. But in summary, the 4 types of insurance available are Life insurance, Total & Permanent Disability, Income Protection, and Trauma. Now if money was no object you would ideally have a package that includes all 4 of these.  But for most people, there is a need to balance the ideal with the realities of their budget.   The crucial thing though is to review your needs, and make a conscious decision as to what cover you will hold.   Personal insurance is very customisable, so there is usually a solution available that can manage your risk, whilst also fitting within your budget. Too often, people get some default life cover within their super fund, and give no thought to whether it is actually fit for purpose.  And they just never even look into Income Protection and Trauma cover. Personal insurance is applicable to us all during our working lives, but especially if you have a mortgage and children, it’s just so crucial that you sit down with someone and put together a package that makes sense for you and your family.  Remember, as we saw in Jenny’s case, the implications of you not having insurance are far broader than just you. Another common financial mistake that I see is not having goals.  In episode 10 – is your ladder against the wrong wall? , we looked at the popular SMART goals acronym as a process to flesh out your goals. Once again, I’ve included detail on this process in the free downloadable toolkit. Sir Edmund Hillary, the great Kiwi, didn’t get to the top of Everest with Tenzing Norgay by just going out for a stroll and happening to find himself at the summit. He set himself a goal, and then went about planning how he would achieve it.  I really like this quote from him: You don't have to be a fantastic hero to do certain things -- to compete. You can be just an ordinary chap, sufficiently motivated to reach challenging goals. You don’t have to be a hero to reach your Financial Autonomy dreams either.  You just need to set your goals, develop a plan that will get you there, and then get started. If you’re a home owner, you likely have equity in that home.  This represents the portion of the asset that is yours, once the mortgage is cleared.  So for instance if your home was worth $1 million, and you had a mortgage on it of $600,000, then your equity is $400,000.  If the house was sold, and the debt paid off, you’d have $400,000 in your pocket in very simple terms. Over time, as you pay-off your mortgage, and as hopefully the value of your property rises, your level of equity rises.  In a balance sheet sense, you are becoming wealthier.  The end game is to eventually pay off your home loan entirely, and own your home outright.  That way, later in life when you no longer have any wages coming in, you know you’ll always have a roof over your head, and you have an asset there that could potentially be sold, to get you into a retirement village or in some other way look after you in your final years. A common mistake I often come across is people viewing this equity as their personal piggy bank.  Banks make this easy with things like re-draw and Lines of Credit, because there business is charging you interest on debt, and so they don’t really want you to pay your home off. This is where regular monitoring of progress towards achieving your goals is important.  Is your debt going down from one year to the next?  All too often I sit down with clients and we find that despite having made home loan repayments all year, their loan balance is about the same as it was when we last reviewed things 12 months ago.  The culprit will usually be the family holiday or the new car. Now housing your savings in or against your mortgage may well be a very sensible strategy, but be really wary of taking back out not just what you’ve saved, but also the repayments that were intended to bring that debt down. Remember, by the end of your working life, and ideally much earlier, you need to own the roof over your head if you are to achieve financial independence and security. I think most Australians are aware that superannuation is important.  But it’s also kind of boring.  It’s easy therefore to pay it little attention, at least whilst in your 20’s and 30’s, and perhaps even into your 40’s.  Hopefully by the time you get to your 50’s, retirement is close enough, and your superannuation balance large enough, that you’ve started to pay some interest. But ignoring your super in those early years is a mistake.  Let’s talk about wonders of compounding for a moment. Let’s say you put $1,000 into an investment, and it earned 10%.  At the end of the year, you’d have $1,100 – the original amount invested, plus the 10% interest you earned.  Now if you left those earnings in the investment, the next year, instead of earning $100, it would earn $110, because not only have you earned 10% on your original $1,000 invested, but you also earned 10% on last years earnings. Go another year and you earn $121 and your balance is now $1,331. This is the principal of compounding in action – you are earning interest on the past interest that you were paid. For compounding to work, you need time.  The longer your money is invested the greater impact compounding will have.  To illustrate the impact, let’s say you wanted to have $1million when you retired, and that was 30 years away. You could figure 30 years is a long way away, I’ll worry about it closer to the time.  Or, if you were able to get your hands on $132,000, and earn 7% a year over that 30 years, you could sip pina colda’s on the beach for the next 30 years because compounding will do your work for you. Now you might say, yeah, but where am I going to come up with $132,000.  But if you’re figuring on retiring at age 65 say, then 30 years out is age 35, and you could very easily have that much in your super fund after 10-15 years of working and earning. The levers you can pull superannuation wise are how your money is invested.  Investing conservatively might seem prudent, but it’s coming at a huge cost in what compounding can do for you.  $10,000 invested and earning 5% over 10 years grows to $16,289.  Had it earned 10% instead it would be almost $26,000.  That’s a big difference. Fund costs are another lever you can pull.  Is the insurance in their appropriate for your particular circumstances?  Are the costs reasonable for what the fund is offering?  The cheapest isn’t always the best, but it’s unlikely the most expensive is either. And then of course you can control any top-up contributions that you make.  Your employer will put in the standard 9.5%, but could you put in a little more? Compounding is extraordinarily powerful, and it’s at its most potent for investments held for a long time.  Your superannuation savings are therefore perfectly positioned to exploit this financial gift. And the final common financial mistake that I see people make is listening to the wrong people.  Now I’ve left this one to last because, as someone who provides financial advice as a profession, I of course have a bias here – you should be listening to me clearly! But in all seriousness, the number of people I’ve come across over the years who go down a financial path because their uncle told them it was a winner, or someone on the radio said the world was coming to an end, would shock you. Just for a moment, let’s assume that the person giving you this advice does actually know what they’re talking about.  You will have noticed that at the start of each episode we have a warning that the information we provide is general information only and you should seek advice that is specific to your circumstances.  Now that’s there because legally it has to be, but it’s not just fluff, it’s a really, really important message. The uncle who tells you that property in woop woop is a really good buy may well be right in so far as he’s looking for an investment that provides a good income return.  But perhaps that’s not what you want. Maybe what would be right for you is a negatively geared investment with strong capital growth.  Perhaps you already have a lot of debt, and borrowing to buy another property would put you under significant strain.  Maybe just paying off your mortgage or salary sacrificing to super would deliver a better outcome for you. Without understanding your complete financial position, these often well-meaning sages have the potential to steer you towards disaster. In 2008 when the share market halved during the GFC, there was no shortage of headline seekers happy to jump on the radio and profess that the world was broken and we’re staring into a bottomless chasm.  This lead plenty of people to conclude that they had better change the way their superannuation savings were invested, moving out of shares and property, and across to cash and bonds. Now perhaps for some people who were quite close to retirement, this may have been prudent.  But for people with plenty of years still to go, this was a terrible decision.  Shares and listed property were cheap at the time, so buying in these sectors via your regular superannuation contributions was really smart and impactful on your balance.  And whilst the value of your existing holdings went down, you weren’t selling so it didn’t matter. Your financial affairs can have such an enormous impact on your life.  Get professional advice.  And with web video calls so good now, you’re not restricted to only getting advice from whoever is local to you.  I deal with clients all around Australia, and when we have a video call on Skype or Zoom, it’s like we’re in the same room.  It’s the modern day equivalent of a home visit. So there you have it, the 12 most common financial mistakes that I see.  Keep those comments coming – what mistakes have you made or come across? Don’t forget to download the free toolkit for this series of episodes – I’m keen to help you take action on the ideas that I share, and the toolkit is a really critical piece in delivering on that. As mentioned previously, I’ve put together something of a bumper toolkit, covering all 3 parts of this series on common financial mistakes.  I have the 12 most common financial mistakes listed so you can tick them off as you’re confident you’ve worked through or around those. I’ve also included the Budget tool to help you get your cash flow under control, a piece on risk vs. reward, useful books, personal insurance options so you can cut through the jargon in this area, and a piece on SMART Goals. So there should be tonnes of useful info in there, so be sure to visit the financialautonomy.com.au website and grab your copy.