How to avoid the most common financial mistakes – Part 1 - Episode 12

Enough people have hit their thumb with a hammer for you to know that it hurts quite a lot. You don’t need to do the experiment yourself. I’ve been helping people as a Financial Planner now for almost 18 years, and I’ve meet many, many wonderful people. Often people put off seeing a financial planner until they’re at some sort of cross roads – they’ve been made redundant, or retirement is rapidly looming, or they’ve separated from their partner. So prospective new clients often come in to see me with some baggage. Something that’s not working, or that they’ve put off dealing with, and that’s why they need our help. Of course over that time you see some common challenges that people face. Issues that repeat again and again. So today I’m going to share some of those with you, the product of my 18 years of helping people, so hopefully you can skip over these common financial mistakes, and reach your goals sooner. We’ve talked a lot so far in past episodes about strategies you can use to help get you to your goals and dreams. Getting a handle on your cash flow, the Survival and Capital strategy mix in moving to self employment, and things like side hustles. Equally helpful though in getting to whatever goal you’ve set, has to be avoiding financial mistakes that don’t need to be made.  Now don’t get me wrong, there are some things we have a go at, and they don’t quite work out as planned.  But we get really valuable learning from them.  I think you can often learn a whole lot more from things that don’t work out as you’d expected, than when things do just fall into place. But what we’re talking about today are mistakes that have been made by people over and over  again, and for which you can get the learning without having to repeat the exercise.   As I said at the top, enough people have hit their thumb with a hammer for you to know that it hurts quite a lot without you needing to do the experiment yourself. When I started planning for this episode, I wrote down a simple dot point list of the common financial mistakes that I see, and I came up with 12.  I’ll try to group them together a bit for ease of absorption. Let’s start with investing, because several of the most common financial mistakes fall into that broad category.  Number one is Procrastination.  Not starting.  I appreciate this can be a broader life problem, but for now I just want to focus on procrastination in an investment context. Whatever your Financial Autonomy goals are, having some wealth behind you is likely to make it easier to succeed.  The stronger your financial position, the more options you’re likely to have. Now building up some savings in a bank account is a really great start, and an essential foundation, but at some point those savings need to be put to work.  The problem is we fear the unknown, and even more so when the unknown involves money that we’ve worked really hard to save. But at some point you need to invest.  Buy some shares, or Exchange Traded Fund (ETF), or invest in a managed fund.  It doesn’t need to be enormous amounts to start with, more important is the learning. An element of the initial discussions we have with new clients is to discuss their risk tolerance or risk profile.  There is no exact science to this.  We have a series of questions we often go through with clients, but sometimes we just have a discussion about their past experiences.  The interesting thing is how people’s thoughts around risk vary depending on what they’ve experienced in the past. So for instance I spoke with a client recently who initially told me they were a fairly conservative investor.  Now in a Financial Planning context, a text book conservative investor would have somewhere less than half of their investment portfolio in shares and property, and somewhere north of half the portfolio in low risk things like bonds and term deposits. So this guy tells me he’s a conservative investor, but we then get into how he has invested his super and it’s 95% in shares.  So we have a discussion around that and he tells me that he just focuses on the dividends, he doesn’t worry much about the prices going up and down.  So when he says conservative, he means he only invests in shares that pay nice steady dividends.  To him, having a portfolio that is 95% in shares is conservative, whereas most people would consider that very aggressive. So why is he comfortable having such a large exposure to investments that fluctuate in value.  Well it’s because he’s invested in shares for over 20 years.  Has dabbled in things here and there.  Some have worked out, and some haven’t.  But over time he’s found what is comfortable for him, and what works for him.  So when markets had a tough time through 2008, he didn’t love it, but he didn’t get particularly distressed, and importantly he didn’t sell anything.  He could do that because he had experience investing, was familiar with the up and downs, and knew that his dividends wouldn’t change much, even if prices did. He’s a better investor now, because he has experience, and he has experience in investing because one day he made his first investment.  He made a start.  He got past procrastination.  So common financial mistake number one is, avoid procrastination – make a start. Mistakes 2 and 3 are opposite sides of the same coin.  Either investing too conservatively, or trying to be a share trader.  Of the two, I’d say the share trader approach is the one with the potential for the most damage in the short term, whilst investing too conservatively is more of a slow burn.  You don’t notice the damage initially, but 5 or 10 years out from retirement, you look at your super and realise it’s not going to get you to the lifestyle that you want. Let’s start with investing too conservatively.  The mindset goes, I don’t want to lose any money.  Therefore I can’t invest my money in risky things likes shares and property.  I need to keep my money in term deposits, or the low risk options in my super fund.  At the extreme end, maybe I keep it all in cash. Now whilst you think you’re protecting your capital from the potential for loss, in fact what you’re doing is baking in disappointment in the future. Some research done by annuity provider Challenger a few years back highlighted this really well. They focused on the risk that your savings will run out during your life time – ie. you run out of money.  They used historical return data from 1900-2013, so it covered a wide variety of economic conditions.  They then analysed portfolio’s with different compositions and considered the results based on drawing down at different rates.  They found:

If you planned on drawing down on your retirement savings at the rate of 5%pa. a level we would typically suggest, and you wanted your retirement savings to last 25 years (retire at 65, money lasts through to age 90), were you to invest in the “low risk” option of 100% bonds and cash (ie. no shares), there is only a 34% chance of success.  That is, a 34% chance that your money will not run out during the 25 year period. If instead you were invested in a typical “Balanced” option, with 50% in growth assets such as shares, and 50% in defensive assets such as bonds and cash, the likelihood of success jumps to 69%. Still not certain enough?  Move up to 75% growth assets and the success rate rises further to 90%.  Interestingly though, move to 100% growth assets, and the success only increases 1% to 91%.

These figures illustrate really well that investing too conservatively, in the traditional sense of minimal exposure to shares and property, is actually the most risky option from the perspective of having your money last throughout your retirement.  The same would apply to building assets to enable the achievement of your Financial Autonomy goals. In the downloadable Toolkit for this episode, I’ve include a piece on risk vs reward that I think you might find really useful, so be sure to visit the financialautonomy.com.au web site to grab that. But as mentioned, there is another side to this coin, and that is the day trader.  If you bump into one of these people socially, run a mile.  There are all sorts of books and bits of software that claim to teach you how to make your fortune trading shares, or sometimes things like foreign currencies or futures contracts.  At the heart of this approach is a belief that you are smarter than the market as a whole (or can be taught some secret formula to make you smarter than the market), and so you can buy shares in the morning, sell then in the afternoon, and make money.  Some people might hold their shares for multiple days, some even weeks.  But the process is the same – they are not buying the share because they have a belief in the prospects for the company, but rather it’s just a trading item. What people who embark on this common financial mistake fail to appreciate is that every time they buy or sell, there is someone else on the other side of the transaction doing the opposite thing.  So for you to win at this game, you need to know something that the person on the other side of the trade doesn’t know.  And because every time you trade, you will have to pay some sort of transaction cost, usually brokerage but also the buy/sell spread, you need to be right a lot.  By chance you’d hope to be right 50% of the time.  To recover your transaction costs and make the whole enterprise financially sensible, you’d need to get that up to 60% as a minimum I would think. So who are the dummy’s on the other side of your trade?  Well increasingly they are super-fast computers that identify opportunities to buy and sell in 100th’s of a second.  Are you going to beat them consistently? If it’s not a computer on the other side of your trade, then the next most likely person on the other side will be a trader acting for a professional investor like a super fund.  Here the fund manager has determined that the appropriate action is to buy or sell a particular stock, and then a professional trader is engaged to carry this out at the best possible price.  Fancy beating that combination on a consistent basis?  Amazingly, day traders think they can. When investing, get started, but don’t be too conservative, and don’t be duped into believing you can be a millionaire overnight by share trading.  These are our first 3 common financial mistakes, and with that I think we’ll leave the investment bucket. In the 2nd part of How to avoid the most common financial mistakes, I’ll share with you another 4 common mistakes, focusing mainly cash flow mistakes people make. I’ve put together something of a bumper toolkit for this and the next 2 podcasts, 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 them. 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 hopefully tonnes of usefulness in there.  It’s the biggest toolkit I’ve ever produced.  So be sure to visit the financialautonomy.com.au website and grab your copy. And finally, a quick note to let you know that from here on we’ll be getting new episodes out to you each fortnight.  We’ve had an initial flurry since our launch – so many ideas I wanted to share with you, but I need to get a bit more disciplined and of course I don’t want to compromise on quality, so from here on, expect a new episode to drop into your podcast app every two weeks.