Ten common mistakes I find when I begin working with new clients:
- Too much insurance. Clients frequently carry more life insurance than they need. While many of us were raised to believe that we should always carry life insurance, the fact is that most of us reach a point in our lives when we can either drastically reduce or eliminate life insurance coverage. Objectively determine how much life insurance is needed to provide for your survivors and then drop the rest.
- Not enough insurance. Many people do not carry enough liability insurance. I recommend that just about everyone carry at least $1 million in general liability insurance. This is available as part of your homeowner’s or renter’s insurance coverage. Many people are still not convinced that long-term care costs pose a significant risk – one worth insuring against. Once you are retired, long-term care insurance is a prudent thing to consider – in the right amount. If you’re not sure what to buy, go for five or six years worth of benefits with a daily benefit limit equal to the average cost of care in your area.
- Paying too much for investments. It’s not unusual to find investors paying 1, 2 or even 3 percent per year to own mutual funds or their equivalent. This is particularly true if the investment is held in a deferred variable annuity contract. In comparison, owning shares in Thrift Savings Plan funds costs less than 0.02 percent. The most important part of any good investment strategy is to minimize costs.
- Too much cash. Particularly during and after bear markets, I find new clients holding too much cash in their investment portfolios. Logically, the time to increase cash allocations is near the top of bull markets, not the bottom of bear markets. If a portfolio devoted to cash won’t produce returns adequate to support your goals, then resist the temptation to go that way. You’ll likely trade away your long-term success for short-term comfort.
- Not enough cash. I also find investors who are so aggressive that they forget to set aside enough cash to cover their expected withdrawals or reasonable emergency cash needs. You should reserve enough cash in your portfolio to cover at least one year’s expected withdrawals or six months’ worth of spending, whichever is greater. This will help to provide a buffer against having to sell securities when market values are unusually low.
- Too much investment risk. Market timing, lack of diversification and inappropriate asset allocation cause many investors to bear more investment risk – risk of failing to produce needed returns – than necessary. As an investment manager, one of your primary responsibilities is to minimize the investment risk you take while getting the job done. Look to the TSP for an example of a virtually foolproof formula for success. It offers diversified, full market coverage at low cost. About the only mistake you can make is not using all five funds, or their equivalents, somewhere in your portfolio.
- Not enough investment risk. Some investors are so focused on avoiding short-term losses that they overlook the need to earn adequate returns. Many people follow this rule of thumb: “It’s generally safe to base your withdrawals in retirement on 4 percent of the starting investment balance, and adjust this dollar amount by inflation each year.” But they don’t seem to realize this rule is only reliable if the portfolio stays heavily invested in equities over their lifetime. If you want to maximize the income that your portfolio will support, you need to take sufficient investment risk.
- Too many accounts. Proliferating investment accounts makes managing a portfolio more difficult and costly, and is often unnecessary. You don’t need to own three different large-cap value mutual funds. One low-cost index fund will do just fine. Keep things simple and consolidate your investment accounts whenever possible.
- Fuzzy goals. I’m amazed at how often people will manage their financial lives according to recommendations they gather from impersonal sources and without any regard for their own objectives. Articles with headlines like “The five funds to own now” is one example of advice you should avoid. You owe it to yourself to clearly understand your goals and then manage your finances accordingly.
- Incompetence. When it comes to financial advice and management, particularly related to insurance, credit and investments, incompetence abounds. Unfortunately, what’s labeled as advice is more often than not just a sales pitch, and many Americans are left to fend for themselves without the necessary capability. It’s up to you to become a competent, reliable financial manager or make sure that you find one to help you. You’ve worked hard to earn what you have. You might have to work just as hard to make the most of it.
Written by Mike Miles
For the Federal Times
Publication July 13, 2009