Following a financial plan and staying disciplined can be challenging. This guide is a quick reference for the main mistakes you should avoid when planning your finances, for example:
- Not addressing risks or building in safety buffers
- Being optimistic rather than realistic
- Missing out on tax relief
- Ignoring evidence and not thinking long-term
No Emergency Fund
An emergency fund is the foundation of a solid financial plan. We recommend holding at least six months’ expenditure (plus any planned additional spending) as an easily accessible cash reserve. Not prioritising your emergency fund can result in:
- Stress when it comes to paying an unexpected bill
- Vulnerability if you are made redundant or can’t work for a time due to illness
- Potential for increasing debt
- Dipping into invested funds early or during a market downturn.
All of this can be avoided if you keep enough cash available to cover contingencies.
Most people have life cover to protect their mortgage. But is that really enough? Consider the following:
- Could your family cope financially if the main earner died? Even with the mortgage paid off, you should think about loss of earnings, the cost of raising children, and additional help at home.
- Could you cover your bills and expenses if you were seriously ill for a few months or years?
- How would you manage if you couldn’t work for a longer period, or were forced into early retirement for health reasons?
- Arranging life, critical illness and income protection cover can address these risks. A cashflow plan can help to work out exactly how much cover you need and for how long.
Not Arranging Protection Policies In Trust
It’s incredible how many policies will still find that haven’t been set up in trust. If a life policy is not in Trust, it will be included within your estate. This can result in:
- A higher Inheritance Tax Bill (40% being paid in tax rather than to your family)
- Delays in distributing the money
- The proceeds not being dealt with according to your wishes.
It’s a simple matter to write life cover into Trust when you set the policy up. It’s always worth checking that any existing policies you own have been set up correctly.
Not Using Tax Allowances
Missing out on tax relief can cost several thousand pounds each year. These are some simple methods for reducing tax:
- Using your ISA allowance (£20,000 per year)
- Maximising pension contributions
- Using, but not exceeding your capital gains exemption (£12,300 for the current tax year)
- Utilising allowances for dividends and savings interest
- Dividing assets between spouses so that both sets of allowances are used
- Making regular gifts to reduce the size of your estate, saving on Inheritance Tax.
A sensible financial plan will ensure that you make the most of the tax breaks available.
Not Following The Evidence When It Comes To Investing
The reality is that few active managers can maintain high performance for the long term. A staggering 97% of US investment fund managers failed to beat the US equity index over fifteen years (source www.SPIVA.com). The only certainty is that you will pay more in investment charges.
The evidence indicates:
- Higher costs will reduce returns
- The combination of assets (equities, bonds etc) has more of an impact on growth than the specific stocks chosen
- Holding a variety of diverse assets is the best way to enhance performance while managing risk
- Trying to time the market is counter-productive, as any knowledge in the public domain is already factored into share prices.
Aligning your investments with your financial plan can help to filter out the ‘noise’ of the financial markets, and keep you focused.
Not Taking Enough Risk
Sometimes we need to take a bit of risk to reach our goals. Over the longer term, equity returns will beat bond returns. Equities are, however, more volatile. There are also different kinds of risk and it’s impossible to remove all of them.
- Some of the potential pitfalls of ‘under-risking’ are:
- Falling short of your goals
- Investments not holding their value when inflation takes effect
Not having a sufficiently diverse portfolio. A bond fund is notionally lower risk than an equity fund, but the value can still go down. A mixed fund allows both asset types to work together, with each offsetting the risks of the other.
Using Inappropriate Assumptions
It’s easy to err on the side of optimism when creating your cashflow plan. This can cause your plan to drift off-course. The longer this continues, the more difficult it is to recover from.
Some examples of faulty assumptions are:
- Overly optimistic investment returns
- Ignoring or underestimating inflation
- Misjudging how much you will spend
- Using the average life expectancy, as there is a good chance that you will live for many years beyond this.
Working with a financial planner can give you an objective view of the assumptions, and help you create a realistic plan.
Putting Off Estate Planning
It’s easy to delay the difficult decisions in life. Making Wills and Powers of Attorney might not appear to be a priority when the need for them seems so far away. But not having these in place can result in:
- Delays and stress for your loved ones as they organise your estate
- Your assets not going to those you intended
- Your wishes not being carried out in terms of medical care or end of life decisions
- Having someone you did not choose making these important choices for you.
Wills and Powers of Attorney are simple and relatively inexpensive to set up. They are also easy to change, so it’s far better to have a not-quite-perfect Will or POA than to have none at all.
Not Following The Plan
Many of the mistakes we see in financial planning arise from poor behaviour and not sticking to the strategy. This can stem from emotions or biases which are not based in fact. For example:
- Chasing fads and hot stock tip
- Tweaking investments every time a major news event occurs
- Selling funds at the bottom of the market due to fear of losing money
- Second guessing the investment plan and changing things frequently.
A good financial planner will aim to coach you towards more positive habits, bringing you closer to your goals.
Please do not hesitate to contact a member of the team to find out more about financial planning and how we can help you.
This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.