Financial gurus on TV or social media love to make the road to financial success sound like a straight and narrow path. Buy index funds, pack your own lunch, and forgo the $5 Starbucks latte – good advice for saving a few dollars here and there, but hardly the type of guidance that will build or maintain wealth. Financial planning is more than just clipping coupons and cooking your own dinners.
Financial planning doesn’t have a hard set of rules because everyone lives within their own unique circumstances. For example, if you’re on pace or surpassing your personal monetary goals, you probably don’t have to eschew the latte. And if you’re overpaying for college or a mortgage, your packed lunches are addressing a symptom of the issue, rather than the root cause.
However, there are some financial traps that anyone can fall into, squandering opportunities to grow or maintain wealth. Here are seven common financial planning mistakes people make in Massachusetts, New Hampshire, and across the country.
1. Assuming That Managing Wealth Requires the Same Skill Set as Amassing Wealth
You’ve worked hard to amass a nest egg and prepare for retirement. You may have worked long hours, forgone vacations, or sacrificed nights and weekends in order to get ahead. Heeding the call to action can make a strong career, but it also could lead to problems with money management. Overactive wealth management can lead to poor decisions and unneeded risk-taking. That’s why working with a fiduciary advisor is crucial. A good advisor won’t just advise you on moves you need to make, but also on when you should just sit tight and follow the plan.
Moreover, someone who has amassed considerable wealth through their income may overestimate their competency when it comes to managing their wealth. For example, an anesthesiologist might be a millionaire because they have an extremely useful set of medical skills; however, those skills that earned them wealth would not be effective when it comes to preserving wealth.
2. Falling into the Social Comparison Trap
Comparison is the thief of joy. An important factor in financial planning is not getting caught up in the rat race of consumption that pits you against your neighbors. I recently heard a great example of this in a story about being on a boat on the water. It is an exhilarating feeling piloting your boat on the open water until you pull into the mariner, and see all the boats bigger than yours!
Are you happy with the car you’re currently driving? Then you don’t need a new one just because your neighbor just bought a fancy new Jaguar. Remember, if your neighbor buys an $80,000 car, all you really know about their situation is that they’re out $80,000.
It’s all too easy for households earning six and seven figures to find themselves living at the edge of their means or even beyond their means. Avoid the rat race and focus on the benchmarks, goals, and budget of your own plan.
3. Failing to Maximize Tax Saving Strategies
Uncle Sam is going to get his hands on some of your assets, there’s no avoiding that. However, you can limit your tax liabilities without crossing to the wrong side of the law.
One of the easiest ways to reduce your tax burden is by taking advantage of tax-deferred vehicles like a traditional IRA, 401(k), Health Savings Account, or 529 Plan. Contributing to these types of accounts will not only reduce your taxable income (perhaps even dropping you into a lower bracket), but also provide tax-deferred growth on your investments. If you are a business owner the benefits can be very significant.
Additionally, tax-prudent investors take advantage of the lower capital gains tax rates (rather than ordinary income rates) and know to offset gains with losses.
Always take some time each year to review your tax strategy. Know what income bracket you’ll fall into, how your investments will be taxed, and how to group your itemized deductions to optimize your standard deductions. A financial advisor with a CPA license can help you take advantage of every tax break available, potentially saving you thousands of dollars.
4. Underestimating the Cost of Education for Children
College costs continue to skyrocket and student borrowers now owe more than $1.5 trillion in higher education debt. A college degree is a necessary stepping stone for many career paths, but even the most conscientious savers underestimate how much a college education actually costs.
According to US News and World Report, the average cost for a year of college in 2020 is over $41,000 at private universities, $26,000 for out-of-state students at public schools, and $11,000 for in-state students at public schools. Even the most cost-efficient colleges will likely come with an overall price tag far north of $44,000. That’s expensive for one child, let alone two or three!
Coverdell ESAs and 529 Plans are available to help parents with tax-deferred growth for education expenses, but education spending will need to be a factor in your financial plan.
5. Not Diversifying Investments
There’s a reason why advice like “don’t put all your eggs in one basket” is passed on from generation to generation. Investment diversification might not matter as much when we’re young and can handle the gyrations of the market, but diversification is important for maintaining wealth as we age. Putting all your assets into a handful of high-flying stocks is often the recipe for disaster. High-flying stocks or sectors can be a great strategy for a portion of your portfolio. It is the boom or bust mentality that investors have to avoid. Especially when they are within 10 or so years of their goal. At that time, it is important to avoid large losses.
Diversification isn’t just about buying different stocks, but also owning different classes of assets. Bonds, cash, real estate, commodities, or hard assets can all have a place in your portfolio, too – don’t neglect them.
A financial professional can help you create a balanced portfolio that aligns with your goals, risk tolerance, and time frame.
6. Mistiming Retirement Withdrawals
You can’t tap your retirement accounts until age 59.5, but you MUST start taking distributions at age 72. Mistiming these withdrawals could result in an unnecessary tax bill or worse, a quicker depletion of your nest egg than you anticipated.
Timing your withdrawals in concert with Social Security distributions and as part of a broader cash flow strategy is smart financial planning. It may seem counterintuitive but it can actually be wise to reduce your retirement accounts to allow your Social Security or pension to grow.
Why? When you start taking your Social Security benefit and later Required Minimum Distributions (RMDs) at age 72 you will be pushed into a higher tax bracket and much higher Medicare Part B premiums. By taking larger retirement distributions before taking Social Security benefits, these distributions can be taxed at low or very favorable tax rates. Later, when the flood gates open with Social Security income and RMD, your RMD distributions will be lower.
With the historically low current tax rates, this is a very good strategy. So talk with your advisor about the best way to begin tapping your funds when the time is right.
7. Neglecting Aging and Estate Planning
No one likes to talk about death or impairment, but you absolutely must consider estate planning in your financial plan.
Everyone needs a will, but what about a trust? How will you delineate your assets amongst heirs? What happens if you become incapacitated and can no longer make your own decisions?
Beyond wills and trusts you have to make sure you properly title all of your assets and name beneficiaries so your heirs avoid the costs and lengthy delays of the probate court process. The goal of every estate plan should be avoiding probate court for your heirs. Unless, of course, you don’t like them!
Neglecting an estate plan means your loved ones will likely have to endure an unwanted situation with the courts that may result in stiff legal fees or unnecessarily high taxes. Estate planning offers peace of mind for you and your heirs.
Financial Planning with Bartley Financial
At the helm of Bartley Financial is Robert Bartley. Robert, who is a Certified Public Accountant (CPA) and a Certified Financial Planner (CFP®), has over 30 years of business experience and over 20 years of experience as owner of his own financial planning firm.
At Bartley Financial, Robert has built a cohesive team where professionalism is valued alongside integrity. Robert and his team apply their expertise to the betterment of their clients, whether that means managing their investment portfolios, planning for retirement, strategizing taxes, or executing any other initiatives in pursuit of optimum financial health and minimal financial stress.
The Bartley Financial family strives to provide unmatched service to clients. They employ a fee-only compensation structure, so clients know that, at Bartley, they come first. Consider enlisting the help of Bartley Financial’s team as you consider your financial goals and how to achieve them.