If you read my previous article on my client Paul, you will find that although there is an array of investment vehicles for you to choose from, it is okay to be skeptical, do some homework and perform your own due diligence prior to making that investment.
Considering you have taken care of the basic foundation in your financial plan (read my previous article on “Why people never plan to fail but simply fail to plan”), anything above your “cash reserve” and “protection” position should be considered for longer term investments.
So let’s get to the meat of this and go over some mistakes people make when investing their money:
- Lack of awareness – It doesn’t hurt to read articles and books on investing, go to seminars, ask other experts, etc.
- Asking the wrong questions from the wrong people – It annoys me when someone decides to go against my expert financial advice because their next door neighbor, a doctor who happened to make a killing in the stock market, told them otherwise. It’s like coming to ask me for advice on what medication to take for your cancer. It just doesn’t make sense. If you’re going to go against my advice, at least let it come from an equally qualified financial expert like myself.
- Lack of Diversification – This goes back to the old adage “don’t keep all your eggs in one basket.” Diversification of financial assets goes beyond simply spreading your money across different banks. There are a lot of other considerations in diversifying your assets (i.e. correlations between assets, track records, fixed vs. equity assets, standard deviations, etc.). So unless you understand these concepts, don’t go at it alone.
- Neglecting Hidden Costs – Anything you do with your money will have a corresponding cost to it. Whether these costs are disclosed or not is another question. Take your money in the bank for example… They might say you can get a FREE savings account that earns 1% (wooptidoo!). But what you probably don’t know is that the bank takes your money and lends it back to you at 5% – 26% in the form of credit cards, home loans, car loans, etc. So what are your costs and how do these costs affect your bottom line returns? That’s the question you should be asking.
- Failure to Identify your true tolerance to risk – Although there is no exact science to measuring one’s tolerance to risk, the financial industry has concocted a “risk tolerance questionnaire (RTQ)” to help gauge the right investment mix for you. Check out this sample RTQ from Charles Schwab.
- Greed – Be wary of investments that offer guarantees and high returns. Those two just don’t mix very well. If it sounds too good to be true… it probably is! Investment return is not the only thing you should be looking at when you invest. You will also want to find out about the investment’s risk, liquidity and how it affects your taxes. It’s all relative!
- Taxes – Assuming about 33% of your earnings go toward taxes. This means that an investment earning 6% will have an effective return of about 4% after taxes. On the flipside, if the same investment earns 6% “tax free,” that means your effective return is 8% due to your tax free savings. Also ask if there are any tax penalties for withdrawing your funds prematurely.
- Failure to identify your time horizon – There are investments that are meant for the short term and others for long term. Establishing your goals for the money you are investing will help you determine whether you should be putting it in for the short or long term. In other words, what is the purpose for the investment? As a rule of thumb, fixed assets (i.e. time deposits, money market instruments, savings, T-bills, etc.) are usually for the short term. Meanwhile, equity assets (i.e. real estate, stocks, mutual funds, variable annuities, etc.) are best for hedging against inflation over the long haul.
Joel Barretto, CFP sold his financial planning practice in Irvine, California U.S.A. to promote financial literacy and awareness in the Philippines. He is a respected Certified Financial Planner practitioner with over 24 years of experience in helping people optimize, manage and protect their wealth.
He is a public speaker and lecturer on a variety of financial planning issues and strategies. With a passion for entrepreneurship, Joel dabbles in venture capital projects and mentors up and coming entrepreneurs on growing their start-up companies. He is a 2nd degree black belt in the martial art of Kempo and enjoys performing and directing stage musicals for community fund raisers.
You can reach Joel at firstname.lastname@example.org.