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“If you don’t know where you are going, you’ll end up someplace else.” – Yogi Berra
This, without question, is my favorite quote about planning. It encapsulates, as only the great baseball coach and manager could, the very first pitfall of financial planning – not having a plan at all.
But that’s not you, right?
Common Mistakes in Financial Plans
You have goals, you have priorities, you have…A Plan. And yet…
1. Does your plan jump to a solution without addressing the root cause of the problem?
It is disturbingly common in personal finance to conflate a specific tactic – a “Great Money Move Everyone Should Make Today” headline – with an actual, enduring answer to a financial problem.
For example, you have high interest credit card debt, and your plan is to refinance the debt at a lower rate. Could be a credit card balance transfer, a debt consolidation loan, or even a home equity loan.
Refinancing will lower your overall interest cost and allow you to get out of debt faster. That sounds like a solid plan, doesn’t it?
But what if you haven’t changed your spending habits that led to the debt in the first place?
Are there long-lasting, perhaps even challenging, choices you need to make either on the income or spending side, to address the root cause of your debt problem?
If you haven’t addressed the underlying reason you have high interest debt, refinancing will not likely lead to being debt free in the long term.
2. Does your plan overlook sources of risk in your financial life (and then fumble the response)?
Stepping back, when we encounter any risk in our lives, we have several ways to respond.
We can simply ignore the risk, transfer the cost of the risk to someone else, or accept the consequences of the risk ourselves.
When we purchase health or auto insurance, that's an example of transferring the economic risk of illness or a car smash-up to someone else, i.e., an insurance company.
When we raise the deductible on our homeowner’s insurance policy, we consciously absorb more risk ourselves while still transferring much of the financial risk of our home suffering damage.
But what about the risk of becoming disabled and unable to earn any income?
According to the Social Security Administration, one-quarter of 20-year-olds today will experience a disability some time during their working years. And the causes of disability may not be what you think.
The four most common reasons why a worker becomes disabled and at least temporarily unable to work are musculoskeletal disorders (tendonitis, arthritis, etc.), cancer, pregnancy, and mental health issues.
What is the proper response if this is now on your radar as a real risk?
As in the above pitfall, do not immediately jump to the solution that seems most obvious, in this case, disability insurance.
If you have a healthy emergency fund or a second earner in your household, you may feel quite comfortable absorbing some of the risks yourself.
What about the risk of losing your side hustle income?
According to a recent study, about 25% of American workers have some amount of “non-standard” income from work such as freelancing. For lower income households, the percentage is much higher.
Is the pay you earn from self-employment, or even overtime at your primary employer, truly extra? Or is it integral to meeting your day-to-day expenses?
If the latter, how are you factoring the possibility of losing that side income into your plans?
The possibility of incurring tremendous expenses for long term care at retirement age is an area where many people, quite understandably, prefer to simply ignore the risk altogether.
Yet we know from research that the average cost of long term care could be as much as $172,000 over a lifetime.
Identifying the optimal response to this risk (transfer, i.e., buy a long-term care insurance policy, rely on Medicaid, or self-insure, i.e., amass extra savings) will require a fairly deep analysis of your realistic options.
A retirement plan that's blind to this risk is not a plan worth having. This is a complex decision you may want to make with the guidance of an experienced financial professional.
3. Does your plan see the trees so clearly that the forest is completely missed?
This pitfall can derail your financial plan in a myriad of ways. For example, perhaps you have heard the phrase “Don’t let the tax tail wag the investment dog.”
Of course, all things being equal, you would enjoy paying less in taxes than more.
Where things go awry is when, in an effort to optimize your tax position to the nth degree, you lose sight of the actual goal.
Are you putting 100% of your long-term savings in a tax-advantaged retirement account, overlooking the benefits of flexibility, and having penalty-free access to some of your savings before the age of 59½?
Or letting tax considerations drive short-term trading decisions rather than a deeper understanding of your investment philosophy?
But this pitfall rears its head in other ways as well.
Was your decision to buy a house driven by the numbers, completely ignoring the lifestyle implications?
As well, there's the too-tired-for-words latte budget example:
Is your financial plan so focused on tracking the minutiae of your daily spending that you’ve ignored the factors really driving your financial crunch…your rent/mortgage, car payment, or even your salary?
4. Does your plan ignore what makes you “you” – the personal biases and quirks that affect your financial behaviors?
Your financial plan, developed on the left side of your brain, envisions you saving dutifully for retirement or a house down payment. Alas, the right side of your brain has other intentions that include an overseas vacation.
Your investment strategy may be to stay firm in equities for the long haul. Except you shudder and sell at the first sighting of a bear (market).
Or conversely, your irrational exuberance for the Next Big Thing leads you to consistently go off-script in search of a better idea.
Automation (auto-investing, auto-rebalancing), dear reader, must be a part of everyone’s financial plan.
More broadly, you must know thyself. And have a financial plan incorporating tactics to save you from your own worst habits and negative financial decisions.
A plan is rarely, if ever, perfect. Still, the wrong strategy can leave you someplace you don’t want to be.
Review and monitor your financial plan regularly to avoid these four common mistakes.
Addressing your plan as life changes will ensure it keeps up with your dreams and money goals. And provides financial security for your future needs.
Article written by Lisa Whitley, AFC®, CRPC®.
Lisa enjoys having money conversations every day with people from all backgrounds. After a long career in international development, she brings a cross-cultural dynamic to her current work to help individuals and families achieve financial wellness.