In one of our posts a few weeks back, we had discussed six financial planning tips for the new financial year. However, just following these planning tips will not yield the desired results if you keep repeating some common financial mistakes. Hence, avoiding bad financial decisions is as important as making good financial decisions. We thought it apt to discuss some of the common financial mistakes that can be detrimental to your long term financial health. In this post, we discuss ten such common financial mistakes:
- We save, not invest: We will have lacs of rupees lying in your savings account and fixed deposits with little exposure to equities. Idle money in savings account and fixed deposits does not beat inflation.
- We invest to save taxes, not grow wealth: We mix investment and insurance. Towards the end of financial year, we rush to purchase products (insurance cum investment plans) that will help us save taxes. Such insurance products are inherently high cost and low return products. Thus, tax saving drives our investment decisions.
- We remain underinsured: It won’t be a big surprise to meet someone with annual income of Rs 10 lacs having a life insurance of Rs 10 lacs. Having such low life insurance makes little sense. Our habit of mixing investment and insurance has a lot to do with this.
- We can’t say ‘No’: This will resonate with most of us. Every time a good salesperson, a relative or a family friend approaches us to purchase a financial product, we eventually end up buying it. A number of times, we know very well that we don’t need such a product. Still, we end up buying it. Why? Because we can’t say ‘no’.
- We think we cannot fall ill: That is one of the reasons a number of us don’t care about purchasing health insurance. It is only when we get hospitalised and have to pay medical bills from our pocket that we realize the importance of health insurance.
- We are too lazy to research: We spend days researching for a mobile phone that costs Rs 10,000. However, when it comes to reading the product brochure for financial products, we neither have time nor will to research.
- We have irrational return expectations: A lot of people I have met want to double their money in a short span in stock markets. So, such people will either invest in the safe haven of fixed deposits. Or if they are investing in stock markets, they want 500% returns in a year. There is no middle path. 12-15% percent compounded return in the long term (through mutual funds) means nothing to them. Little surprise that such people lose heavily in the markets and are then too scared to come back.
- We don’t diversify enough: A lot of us have investment concentration in a particular asset class. Some of us invest only in real estate. Some will have most of the investment in PPF and fixed deposits while others invest solely in equities. This habit does not give us sufficient diversification. Diversification of assets is important not just for correlation of returns (reduction in risk) but also from the perspective of liquidity. If you have your 90% assets in real estate, in case of financial emergency, you might be forced to liquidate your asset at a significant discount to market prices.
- We take too much leverage: Most people, I have met, are averse to taking on debt. But I have seen instances where a major part of monthly income goes towards different loan EMIs i.e. Housing loans, car loans, credit card loans etc. Payment of such EMIs does not create any asset (apart from housing loan). Not just that, it leaves little to invest which can impact your long term financial health.
- We think real estate will only appreciate: Not all decisions that you make are borne out of financial compulsions. Thus, buying a house to live in makes perfect sense. However, going on investing in real estate with the belief the real estate will only appreciate can backfire. Rental yields in bigger cities have fallen to as low as 2.0-2.5% per annum. I am no expert in real estate. However, with such low rental yields, it won’t be surprising to see real estate falling in the near future. This belief also leads to over-leverage (to purchase houses for investment) and concentration of investments in real estate.
It is not easy to get rid of these habits because we have been brought up this way. I have some of these mistakes myself. However, it is never too late to acknowledge and rectify these common financial mistakes. It will be beneficial for your long term financial health.
Deepesh is a fee-only financial planner and is Founder, PersonalFinancePlan.
Photo Credit: Hobvias Sudoneighm 2008. Original image and information about usage rights can be downloaded from Flickr.com
