In my years as a financial advisor, I’ve seen many families achieve financial success and enjoy the subsequent benefits. Unfortunately, I’ve also seen people make entirely avoidable mistakes that had long-lasting effects.
Today, I share 6 of the top mistakes I’ve seen wreak havoc on investors’ financial futures.
1. Delaying retirement saving
One of the basic principles of financial success is to pay yourself first. Sadly, one of the most common mistakes people make is simply procrastinating. It’s also one of the most devastating.
Due to the power of compound interest, every dollar you invest in your 30’s and 40’s is worth exponentially more than the dollars you invest in your 50’s and 60’s.
Did you know that a 30-year-old who waits 5 years to start saving for retirement could see a decrease of 30% in retirement income? Waiting 10 years could result in a reduction of more than 50%.
In short, delaying your retirement savings means either delaying retirement or drastically reducing your standard of living.
Key takeaway – Compound interest is your friend. Start investing today.
2. Saving, but not investing
Have you ever had a parent or grandparent tell you about how they bought their first house for $30,000 or how they could buy a soda pop for a nickel when they were a kid? You might feel a bit of jealousy, but don’t fret too much, salaries were also much lower back then.
During the 20th century, inflation averaged about 3% per year, meaning prices doubled about every 20 to 30 years.
What does this have to do with your retirement?
A lot.
It means that putting your savings under your mattress (or in a bank account paying close to 0% interest) is not a viable investment strategy. It means in 30 years your cash will be worth about half of what it’s worth today.
So, if you think you’re doing the “safe” thing by keeping your retirement funds in cash, think again.
Key Takeaway – Saving isn’t investing. Inflation will erode the purchasing power of cash.
3. Owning too much company stock
A friend of mine worked his entire career for a well-known energy company. Over the years, he accumulated a large amount of stock in the company. He felt loyal to the company that had provided for him and his family. It also felt safe to him. He knew the industry. He knew the people. He knew the culture. It was a solid company.
Then out of nowhere, in 2014 oil prices plummeted. Over the next year, the company’s stock price dropped nearly 50%. It didn’t matter that it was a good company.
Regardless of how well you think you understand the company or industry you work(ed) in, holding a large portion of your investment portfolio in a single company is highly risky. Most investors can’t afford to take that risk.
Key Takeaway – Don’t put all your eggs in one basket.
4. Falling for get-rich-quick schemes
One of the simplest, and most important, investment concepts is that risk and reward are related. Investors that fall prey to Ponzi schemes like those run by Bernie Madoff ignore this important concept.
But if you think about your own finances, it’s not hard to understand. Compare the interest rates on your mortgage and your credit cards. Credit cards charge much higher interest because people default on their credit cards much more frequently, and because credit cards are not backed by an asset like a mortgage is. Lenders require a higher return for credit cards due to the higher risk they are assuming.
Investing is no different. Investments that offer higher potential returns involve more risk.
If your friend or neighbor comes to you with a “once-in-a-lifetime” chance to get in on the ground floor of some new business venture, ask yourself these questions:
- Why are they coming to me?
- Where else could they get financing and why aren’t they pursuing other, cheaper options?
- Why would they offer me such amazing potential returns?
Often, we let our greed and our “fear of missing out” guide us in these decisions, instead of our common sense.
Key Takeaway – Don’t gamble with your retirement. If it sounds too good to be true, it probably is.
5. Letting fear guide investment decisions
Our quick fight-or-flight response to danger is what kept our ancestors alive. However, that same emotional response can lead to terrible investment decisions.
I recently wrote about a concept called the “Behavior Gap” which is the difference between what the market returns and what investors earn due to their poor decisions. This gap can reduce your retirement nest egg by hundreds of thousands, or even millions of dollars.
One of the most egregious examples of this is when investors sell after a large market drawdown. Investors who are in or near retirement are most prone to panic when they see their nest egg reduced. However, selling after a bear market like 2008 can cripple your retirement plans forever.
To avoid this behavior, it is important that you understand the risks you are taking. With that knowledge, you can feel confident in your long-term strategy during difficult markets and maintain discipline when your instincts tell you to cut and run.
Key takeaway – Following your instincts is a terrible way to invest. Discipline is key.
6. Paying excessive commissions and fees
One of the most frustrating things for me to see as a financial advisor is people who have wasted money on expensive investment and insurance products.
I have sat across the table from many clients who have been putting $1000’s of hard earned money into whole life insurance for years, and still, have little-to-no cash value in their account. That money isn’t recoverable. It’s gone.
I’ve also seen clients who were sold annuities, REITs, and other products that can pay commissions of 7% or more to the sales reps. Of course, these products may be appropriate for some investors, but the terrific commissions make it difficult for the salesmen to remain objective and erode investors’ returns.
Key takeaway – Know what you are paying and only pay for the things that matter.
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