Devilish Details: Top 10 Financial Planning Mistakes

top-10-financial-mistakes

Andrew Allentuck

Chloe Cushman


Family Finance receives an average of 25 email inquiries a week, most in the day and day after the

column appears, from readers who want to repair their financial futures. Their concerns vary from

wanting to confirm plans they have already made to seeking relief from dire prospects. Many want to

fix problems they should have seen and addressed long ago.

Over more than two years, Family Finance has gathered a composite, somewhat expected, picture

of folks who ask us for help. Early in life, people take on debts, mostly mortgages. As they move

through life, net worth rises. After age 60, it is more unusual among Family Finance submissions

to find people with debts in a multiple of two or more times income. Yet there are similarities in the

mistakes made by all. Here, we highlight 10 common financial missteps, the thread of which runs

throughout our weekly series.


Passivity “Many people believe that in event of a crisis or even down the road in life, everything

will be covered,” says Caroline Nalbantoglu, a financial planner at PWL Advisors Inc. in

Montreal. “Life is not like that. A non-indexed pension that looks good in mid-life can be eroded by

inflation. A will drafted in one province may not be interpreted as planned when one dies resident

in another province. Failure to draft a living will can expose assets to misuse if one is seriously

incapacitated.” Rule: Consider contingencies, what will happen in life, what can happen if bad luck

strikes, and prepare for risk.

Related

Inflexibility

Plans once made need to be reviewed periodically. It is helpful to get perspective, sometimes by

adding the eyes of professional advisors, says Adrian Mastracci, a financial planner and portfolio

manager who heads KCM Wealth Management Inc. in Vancouver. “It is a matter of expectations,”

Mr. Mastracci says. “Paradoxically, the methods used to build a fortune can wreck it.” The belief that

what is will be is the problem. For example, a will drafted in 1980 instructed trustees never to invest

in anything but short-term government debt that, at the time, paid as much as 15% a year. Today,

those treasury bills pay 1% to 2%, and fortunes invested in them have been eviscerated by inflation.

The implication: Lack of foresight combined with inflexibility can doom a fortune.

Failure to save

This is a fundamental failure, yet many people spend what they don’t have with credit cards and

loans with little idea of when and how the loans will be repaid. Economists call erosion of net

worth “dissaving.” It is responsible for many consumers’ financial anemia.

Procrastination

Of course, there’s the biggest planning error of all — procrastination, says Andy Husband, head of

A.M.H. Financial Services in Edmonton. “People don’t want to confront today what they can defer to

tomorrow,” he says.

Overpaying for financial advice

It can happen in a bill from a fee-only planner. And it can happen without being noticed when

advisors who sell mutual funds that provide annual so-called trailer fees to advisors for keeping

clients in the funds are overpaid. For example, a $1-million mutual fund account with an average

2.5% management expense ratio has an embedded $2,500 annual management expense. The advisor

may get 40% of that fee, or $10,000. For a $2-million portfolio, the fee is double and the advisory

work would probably be much the same. It’s vital to price advisory services. After all, a 1% annual fee

adds up to 20% in two decades. What’s more, the cost is certain, the benefits of advice are anybody’s

guess.

Planning to retire too early

A major Canadian insurance company built a vast book of business by marketing its services with

the pitch that people can retire at age 55. Few people have sufficient resources to pull it off. Yet the

notion has spurred retirement planning at age 55. What happens, of course, is that it is necessary

to wait five or 10 years for the Canada or Quebec pension plans to kick in and for Old Age Security

benefits to flow. In the gap, people have to use up their savings. What’s more, they give up a decade

of potential savings. In the end, few people are adequately prepared to retire at age 55.

Failing to cut debt

There are three tiers of debt. First is mortgages and lines of credit secured against a home with

interest rates of 2% to 5% or so. Then there is debt on universal plastic like Visa that is billed at 15%

to 18%. And, finally, there is retail plastic debt at rates up to just a hair under 30%. Planners strive

to help people to deleverage their debts, usually by cashing in stocks or other assets that are not

likely to beat what they have to pay to lenders. The best rule: Don’t take on debt with double-digit

interest rates. Investments seldom match it and, compounded, it can eat you alive. If you do have

such debt, pay it off as soon as possible. Don’t let interest compound if you don’t pay or don’t pay

enough and be sure to eliminate all non-tax-deductible debt by retirement. Keeping cash in low-

return investments might be better off used to pay off debt.

Buying rental properties without estimating returns

Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., says the failure to do pencil

work on real-estate deals is the cause of many family portfolio flops. The two elements of property

investment — cash flow from net rents and growth of equity through mortgage paydown — can be

estimated prior to the time of purchase. Capital gains can’t be planned, but if a property pays for

itself, you can afford to wait for gains.

Carrying more risk than appropriate through failure to diversify

Most people have no idea of what an asset mix is, Mr. Mastracci says. The asset mix predicts the risk

level of the portfolio. If you have bonds that tend to rise when stocks fall — and vice versa — and

some commodities or investments in commodity funds that track inflation, then risk is diversified.

There are still questions of balance — how much of each — and of picking the right assets in each

class. But a portfolio assembled with those balanced characteristics will tend to weather financial

storms, he says.

Not being emotionally detached from investments

It happens with surprising regularity. You can like a stock or a rental apartment building. Ego gets

in the way, for dumping an investment seems an offence of ego. Moreover, if a rental apartment is

occupied by your child or sibling or parent, it may be hard to sell. “Family and business do not mix

well,” Mr. Moran says.


(C) 2012 The Financial Post, Used by Permission