Simply put, financial management is understanding how much you earn and how much you should be spending in order to have a certain surplus by the next time your earnings turn up in your bank account. That involves financial planning and making and following a structure that you can comfortably adhere to without being unduly pressured at any given point of time. There are always significant expenses which will require money to be carefully saved and invested, so the long-term returns can prove useful in those times, or even during emergencies.
This is why planning for the future is important, keeping clear and distinct goals in mind. Let us understand the 10 most common mistakes people make while planning their finances.
No Contingency Fund
A contingency fund is something that will help you tide over any unforeseen disruption in income. This should ideally be an amount that comprises around 6 months of your expenses. You should not consider what you can manage with/without - it should cover everything from a bar of soap to an extended bed rest in case of a medical emergency.
This fund should be your first priority, even before you think of stashing away some of your income as savings. Keeping this amount in low-risk and highly liquifiable debt funds is the best option. Since they are an investment, you would think twice before casually spending it all, and at the same time, they can be easily converted into liquid funds should there be any emergency. The returns you get on this is not a priority, since this will be used in the worst-case scenario. The rest of your financial management begins after you have decided the best way to achieve this.
Delaying in Setting Financial Goals
Setting clear goals is the first step to acquiring financial security. Maybe you want to own a particular car, or build your dream home, or have a lump sum amount to start your own business - any of these will require good financial planning and mistakes can cost you quite a bit. So, once you have set a goal, make sure you follow through the steps diligently to achieve that goal within the time frame you wanted, the earlier, the better. It is very harmful to not plan meticulously and accomplish your goal. After you have set up the priorities and goals, then take a few moments out of each day (or as often as you can) to watch how well are you doing with regard to these goals. This will help you monitor progress towards your set financial targets.
Being impatient and acting too quickly on impulse emotions in unexpected situations can cause an unfortunate downward spiral from which it is impossible to recover from. Perhaps the most difficult aspect of improving personal finances is resisting the urge to react emotionally when times get tough, but the key lies in distinguishing between ruining your credit rating, savings or retirement money and having an effective self-management plan.
Not Exploring All Available Investment Options
You might have started out your financial planning with a savings account or might even have opted for a fixed deposit or even a recurring deposit, but that is not where the world comes to an end. A life insurance policy is not an investment for yourself, it is a support system for those you leave behind. Anyone who tells you otherwise is simply trying to sell you a policy, with the allure of returns at the end of the maturity period. Having a life insurance policy is good, but it is not an investment you can build something upon.
Considering the interest offered by fixed deposits or other traditional investment options, your real value of money continually erodes over time. Always be on the lookout for newer investment options that are more tax-efficient and offer inflation-adjusted returns. To start with, you could create a few SIPs for mutual funds, then move on to explore rare earth metals, real estate and the like.
Getting Investment Products Based on Hearsay
At the end of the day, it is your money that will benefit or be harmed by your financial planning. Just like your investment goals are unique to you, so will be your investment portfolio. If a product works well for a friend or a relative, it doesn't mean it will work the same way for you for the period you have in mind.
One of the biggest mistakes people make when it comes to financial planning is getting investment products based on hearsay. Just because your friend or neighbor is doing well with a particular stock doesn’t mean it’s right for you. It’s important to do your own research and talk to a financial advisor before making any decisions about investments.
Insurance is Not Investment
Well, we have said it before, but this is one of the major mistakes that people do unwittingly, or maybe by being swayed by the big returns promised. Always understand that any policy that demands more than the cost of covering a risk is a packaged investment. It's not like they are bad options, but you'll be in a bind to understand how much of it is going to be investment and how much is going to be the insurance bit, if in case you are in some sort of life-threatening risk. It is better to go for a life insurance policy that provides proper coverage, and then choose proper pure investing tools for your investment planning.
Ignoring Inflation when Planning for Retirement
Inflation is key when it comes to wealth growth. If your investments aren't generating returns beyond the rate of inflation, the value of your money is actually eroding. Keep the inflation in mind, think about lifestyle changes, your expenses after retirement, medical care, and sundry expenses while planning for retirement. This stage of financial planning is best done along with the guidance of a qualified financial planner. Well, if you are good at calculating all the aspects mentioned here, you can very well do this on your own.
The Wrong Frequency of Paying Insurance Premiums
A unit Linked Plan, or ULIP is a great insurance product, but if you choose to make yearly payments instead of monthly ones, you are losing out on units, which affects the growth of your money. Ensure you pay the premium on a fixed date every month to reduce the impact of market volatility. Understand that regularity of payments is one key aspect of good financial planning.
Repaying Loans at the End of the Month
This one is relatively less known, and often slips past the radar. But if you choose to pay your EMIs at the end of the month rather than at the beginning of the month, you might end up paying EMIs for many more months, for a bank loan of say, 20 years. Thankfully, most banks set up an auto-debit in the first week of the month itself, unless specifically asked not to. Your financial planning should not be dependent on how much money you have left at the end of the month, but rather how much comes into your account at the start of the month.
Not Rebalancing Your Portfolio
Last, but definitely not the least, it is a pipe dream if you think all your investments will continue performing the same way till you achieve your goal. Yes, low risk instruments will continue to deliver on their promise, but the growth through them is quite negligible. If you have invested in multiple instruments and assets, an annual analysis of how they are performing will give you an idea on when to switch tracks. Certain investments, like commercial real estate, bank on capital appreciation for their growth, so those can be excluded, but everything else can be assessed to minimize risks and maximize returns. Financial planning and management rely heavily on diversification and rebalancing of portfolio, so always bear that in mind.
Conclusion
There are a lot of financial planning mistakes that people make, but luckily, there are also a lot of ways to avoid them. By being aware of the most common mistakes and taking steps to avoid them, you can set yourself up for financial success. So, if you’re looking to get your finances in order, be sure to avoid these mistakes! And if you are looking for an investment option that steps out of the traditional sense, why not explore fractional ownership in commercial real estate via Strata?
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