5 Biggest Financial Mistakes On The Path To Financial Independence
I have been in financial services for over 2 decades, and there are 5 things I see (over and over) that take people away from their financial success.
- Spend > Earn
- Retire Too Early
- Panic Sell
- Excited Buy
- No Planning
Spend > Earn
This one seems so obvious, yet so many people do it. I hear different versions of “I don’t have a choice” all the time. It is very rare when this is true.
If you fall in one of those spaces where this is your reality, then my heart breaks for you. It may not be your fault that you're in it, but you will probably need to get yourself out of it. Perhaps you lost a job in a bad job market, your bread-winning spouse died, or the business you've invested everything into just went under. These are all awful and difficult. You have to believe that it won’t always be this way, and you have to take disciplined steps to increase income and reduce expense. Only you will have the power to get out of it.
For most of us, we have to make a hard choice. We have to take responsibility. We have to make changes.
This mistake presents in two different ways:
- Chronic: The regular – Paycheck-to-Paycheck – use of credit to make ends meet
- Acute: The too-nice car, too-big house, too-much vacation, boat, plane, vineyard problem
In either case, compassionate tough love is a necessity – the earlier the better.
This is difficult for an advisor to affect. We can’t always be there when someone is about to spend more. The best we can do is:
- Help you know how much you can afford to spend (vs. need to save)
- Be available for your questions about spending (especially when you're concerned you may overspend)
Retire Too Early
There is a point in our saving/investing lives when our assets are large enough to spin off an income that rises to keep pace with our rising cost of living, AND keep a couple years of spending in an emergency cash account to draw on when our invested assets aren’t working.
If you retire before that point, without serious spending discipline, you will eventually be drawing on principle. The moment this happens, the downward spiral begins. This year you draw a little principle, next year it has to be a little more, the year after that even more. People justify each year to themselves and their advisors, but the math works against them. After 10 years, you have accelerated the use of your principle to such a degree that without drastic spending (read: lifestyle) cuts, you run out of money long before you run out of life.
This has been variously managed with different starting retirement rules:
- 4% safe-withdrawal-rate – you invest in (at least) 60% equities and limit withdrawals to 4% of the portfolio
- 25X your spending in assets (just another way to talk about the 4% withdrawal rule)
- Bucket Strategy
- Short-term bucket – perhaps 5 year fixed annuity payments
- Medium-term bucket – balanced portfolio designed to fund years 6-10
- Long-term bucket – more aggressive portfolio designed to fund 10+ years
Each of these rules is a plan that has a minimum asset size at the outset, and a maximum spending amount for the rest of your life. Breaking either of these leads to failed retirement.
Panic Sell / Excited Buy
These are two different errors but they are two sides of the same coin. The name of this coin is “prediction.” I have written about this at some length HERE.
As investors, we have a choice. We can be:
- Market-focused and performance-driven – attempting to minimize short-term downward volatility and maximize short-term upward volatility by buying and selling different investments at the “right” time based on economic forecasts and market predictions, or
- Goal-focused and planning-driven – attempting to minimize long-term regret by embracing short-term unpredictable market volatility as the only way to capture the long-term returns we need to fulfill our plans.
The first one doesn’t work long-term, because no one can consistently predict where the market will go next. Sure, in hindsight we see that some people get it right sometimes. But we cannot know which forecasts will turn out to be true beforehand, and no one in history – yet – has done it with regularity. There is an overwhelming amount of academic research that supports this as true.
But, do we really need to read an academic paper to know that prediction doesn’t work? How can we believe that we can predict, when we can barely explain things that have already happened?
Every time we panic-sell out of some concern for a market direction or pending economic crisis, we are predicting.
Every time we excited-buy based on an investments potential or a probable economic upswing, we are predicting.
When you predict, you might be right and you might be wrong. When you invest based on changing predictions, you increase your expenses and your taxes… and the house will win in the end.
The ONLY intelligent progression of a lifetime investment program is:
#1 Goals – time-specific & dollar-specific needs
#2 Plan – step-by-step process for accumulating the specific amounts in the allotted time for each need
#3 Portfolio – the historically appropriate balance of equities vs. fixed income that will produce the returns necessary to support the accumulation of the specific amounts in the allotted time
A plan takes into account multiple goals across multiple time frames; it takes into account available savings and potential for more savings; it considers returns and inflation and the variability of both.
In the short run, returns can be wildly variable, whereas inflation is usually more stable – so portfolios for short-run goals will often hold proportionally fewer equities.
In the long-run, inflation can be more variable and eat away at purchasing power, while returns can stabilize around an average – so portfolios for long-run goals tend to hold more equities as a percentage.
We cannot know how to invest without knowing the variables discussed above. If you can add more from savings, then you can get by with lower returns. If you need the money in the short-term, then you can’t rely on the long-term return of equities.
You can invest, and perhaps rely on, the impossible promise of the market-focused, performance-driven portfolio (that you can predict outcomes).
Or, you can identify an “appropriate” portfolio by creating a plan.
Having a plan and making intentional trade-offs between the variables will increase the probability that the portfolio you put in place will help you reach your goals.
First Goals -> then Plan -> then Portfolio
Thanks for reading. I hope these 5 potential pitfalls are clear to you. You can solve for them yourself. We have some great financial education courses that can help. You can hire our team at EP Wealth to do it for you. Or, alternatively, you can do it with us.
We have designed our twin offerings – the Mindful Money Membership & the Mindful Retirement Review Workshop – to solve for these 5 mistakes.
Mindful Money Membership solves for the responsive portion of #1 and members' needs re: #3 & #4.
Mindful Retirement Review Workshop solves for the planning part of #1 and attendees' needs re: #2 & #5.
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