- Body & Beauty
- Health & Healing
- Mind & Emotions
- Everyday Wellbeing
Even the financially well-off make these mistakes
You may have heard of the Pareto principle [also known as the 80-20 rule]: it says that for many phenomena, 80 per cent of the effect arises from 20 per cent of the causes. Even your small investment mistakes too have that impact on your overall finances. My promise to you is that if you take care of the five points discussed below, a good deal of your financial planning related problems will get taken care of.
The first thing you need is to prepare a written financial plan to give concreteness to your plans and ensure that you don’t deviate from the course.
Since most individual investors lack the knowledge for preparing a detailed plan, it is best to approach a trained financial planner to get this work done. The financial planner will ask you to fill up a detailed questionnaire to gauge your risk appetite, your current financial situation and your goals among other things. It is on the basis of this information that the plan is prepared. When your plan is unclear, you end up investing wrong. If your portfolio of wrong investments is big and a lot of time has gone by, undoing these mistakes becomes costly and difficult.
A correlated mistake is to buy the flavour-of-the-day product. When the equity markets are doing well, the launch of NFOs [new fund offers], sector funds, and IPOs [initial public offerings] becomes frequent. The investor is lured into buying these high-risk products that he can well do without. Then the bull run ends, the value of these investments crashes, and the investor regrets his impulsive purchases.
So, get a basic portfolio in place with a select number of correct products and then stay the course.
I come across numerous portfolios where the bulk of a person’s investments are in insurance-cum-investment products, such as ULIPS [unit-linked insurance plans], moneyback and endowment plans. This creates problems. The first problem is that investing in insurance-cum-investment plans leaves us inadequately insured despite paying a high annual premium. The second problem is that these products are costly and affect final returns. Some products have high surrender charges in the initial years, which makes opting out of them difficult even if we are dissatisfied with them.
To avoid these troubles, buy a term plan from an insurance company for adequate insurance cover and use mutual funds to meet your investment goals. As said, get adequate insurance. The sum assured of the term plan must be sufficient to replace the breadwinner’s income in case of an eventuality. To determine the right sum assured, most people follow the rule of thumb: sum assured equal to 10 times annual salary.
Also, most working couples depend just on employer-sponsored health plans. But what if you fall ill between jobs? This is not as uncommon as you might think. When Lance Armstrong, bicycling champion and seven time winner of the Tour de France, was diagnosed with cancer, he was in the midst of changing his team [sponsor] and was without an insurance cover. Besides, getting health insurance is difficult once you cross late 40s.
A number of double-income couples who, despite earning well, don’t save enough. Many live for the day, splurging on whatever catches their fancy. Worse still, some even rake up personal loans and large credit card debt.
Pay off all high-cost debts. Only car loans and home loans are permissible as they help create an asset. Next, invest at least 30 – 35 per cent of your gross monthly salary.
Establish a contingency fund. This must equal at least six months of your household expenditure [including insurance premiums, tuition fees and other big bills that come up from time to time]. Put this money in a bank deposit or a liquid fund where it can be reached quickly in an emergency.
Most investors don’t give adequate thought to asset allocation [how much they will allocate to equity, debt and gold]. But this is perhaps the most significant decision you will take in your entire financial life. Studies show that more than 90 per cent of the final outcome [the corpus you accumulate] depends on your asset allocation.
Your asset allocation should be a function of your risk appetite and your investment horizon. In your retirement portfolio, it’s okay to have a high percentage of equities because it is 15 – 20 years away. The same goes for children’s education portfolio [where you have 15 years or more]. When you are three years away from your goal, start reducing your equity exposure and hiking the debt exposure so that a last-minute crash in the equity markets does not deprive you from achieving your goal. Also, many people end up investing heavily in real estate. Too much real estate restricts liquidity since disposing it at short notice is difficult.
Many high net worth individuals are guilty of this mistake. Some even keep financial secrets from their spouses. So if something happens to them, their spouses often don’t even know the ATM password to access the money in the savings account. No one in the family knows where the person has invested the money, and where the relevant financial documents have been kept. Absence of a will also leads to litigation among inheritors.
So, prepare a will even if you are in fine health to ensure a smooth handover of assets. Also, prepare a detailed document that lists your investments, how to access them and the passwords. Also mention the key payments to be made during the year. Inform your spouse where you have kept this document. Further, when investing, name the nominee with due thought and care.