The Paladin Press

August, 2005

5 Biggest Money Mistakes

What determines success or failure in our finances?  Is it superior planning, good luck, or just sticking to the basics?  Most would argue it is a combination of the three, but few would be able to identify those basic principals if asked to list them.  Just look at the recent events in the media and we discover confirmation that our plans don't always work out the way we hoped.  It's so simple to talk yourself into the wrong moves.  Ever buy a stock or fund because it seemed like a sure thing?  Ever promise to increase your savings?  Or commit yourself to reducing frivolous expenses?  If you have never done any of these things or never had to, then please stop reading.  You're a perfect money manager and don't need to read this article!  For the rest of you, consider this a lesson on the basic principals of money and use it to trigger the changes necessary. 

Actually, there are many more than 5 mistakes impacting our financial success.  But these were identified in a recent Merrill Lynch study as those that could cost your family $250,000 in the long run.  With the average net worth of a retiree being only $264,000 in 2004, this is a significant number for most families.  Avoid these 5 mistakes and you could double your retirement nest egg. 

1.  Not Saving Enough

This is mistake number one, without question.  Few actually are on track to achieve their retirement goals.  Most can't even describe the goal.  Ask your friend's about their goal.  They'll say something like, "To retire comfortably at 55 or 60."  Maybe they'll even know where they plan to live.  But few can lay out the specifics of the plan.  Is it to make as much money as they do now, more or less?  Without the details, how can you be sure you are saving enough money for this goal or any of the interim goals like college expenses, or the new house?  Current average household savings in the United States is less than 2% of income.  This means that barring inflation or any other erosion on the dollar, and assuming income stays the same; it will take 50 years just to save one year's salary.  Could this be the reason why so many people feel forced to take substantial risks with their money? 

Thanks to the tax law changes of 2001, there are opportunities to fix this problem.  401k contributions are allowed up to $14000 per account holder and there are catch-up provisions for those over 50 for an additional $4000.  Of course, this entire savings creates a future tax bill, so the use of tax-free retirement strategies like the Roth IRA may be a better solution.  IRA contributions are capped at $4000 with a $500 catch-up provision for 2005.  The perfect solution in most instances is to contribute to your 401k up to the employer matching limit, then seek out other options for the remainder of your savings.  Either way, work towards saving 20% of your income and you'll have a chance of achieving your long-range goals.

2.  Taking Too Much (or Too Little) Risk

The future is holds many surprises.  Even the experts failed to see the things that impacted market performance over the past 10 years.  In the late '90s, too much risk was a good thing for your portfolio - until it ended!  Flash forward to 2005, and many investors are risk-adverse.  They've been burned once and aren't anxious to experience it again.  That being said, any investment, by definition involves some degree of risk.  The key is to maintain balance and follow an investment policy that keeps risk in check.  A financial advisor can help you establish the policy and implement your plan to ensure your level of risk is controlled.  More importantly, your advisor can help you avoid the costly mistakes of taking on too much risk in an attempt to make up for the savings shortfalls discussed earlier.

3.  Not Diversifying

Everybody knows they shouldn't do it.  But when your company stock keeps going up, it's hard not to focus your money there.  Many company plans actually make it hard to put your retirement savings elsewhere.  Diversification is the key to protecting your accounts from severe downturns in a certain sector of the market. As you establish your investments, ensure that they are diversified across the market sectors, not just split between stocks and bonds. Mutual funds are an excellent way to accomplish this. However, many mutual funds are similar in their holdings, so it is important to make sure you have not chosen funds that replicate one another.
4.  Raiding Retirement Accounts
After years of saving, many people look to their retirement accounts as a resource when it comes to large expenditures. From home improvements to vacations, Americans are great at tapping their retirement accounts early. It is important to remember the purpose of your accounts, and to fully understand the impacts of early loans or withdrawals. In most cases, a 401k loan removes the outstanding funds from the earnings calculation. This combined with the loan interest creates a substantial opportunity cost over time.
5 .  Ignoring The Tax Man
Nothing has a more dramatic impact on the value of your portfolio than taxes. Taxes can erode up to half of an account value over time. Tax-deferred accounts of course defer this to the liquidation stage, which could actually lead to a higher tax rate if not properly planned. It is extremely important to work with your accountant and advisor to plan your retirement distribution to minimize the impact of taxes. Likewise, these impacts should be part of every decision made with the remainder of your portfolio that is not in a tax deferred account.

While not a comprehensive list, these five mistakes are common and have the potential to greatly erode your potential net worth. If you have any questions regarding any of the above issues or just want to review your financial decisions, please contact us to schedule a meeting.