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Financial Life-isms, Fact or Fiction

Most people learn financial habits from their parents or close friends.  Many of these financial habits are passed down from generation to generation like folklore.  In my practice of Financial Planning here are 3 financial topics that come up in every conversation I have with a client.  You decide whether they are “Fact or Fiction”. 

You must be lucky to be a successful investor.

According to a study by State Street’s Center for Applied Research found that the way individual and professional investors made investment decisions was so skewed that achieving both high returns and long-term objectives was nearly impossible.  Folklore Finance.

This study stated: “….people were overconfident in their investing ability, unable to focus on their stated long-term goals when distracted by short-term noise in the markets, and had come to distrust their advisors and lose interest in receiving professional investing help.”  

Most prospective clients I have met have been unsuccessful investors.  It stems from a misplacement of investing focus.  In most cases their focus has been “market driven” (something that is beyond our control) as opposed to “planning driven, or objective based” (something we can control and define easily).   For many investors who have become disillusioned with investing, they equate the ownership of stocks to going to the casino, purely like gambling.  But in my experience the process of preparing a Financial Plan needs to take place prior to making any investments.  After which is it easier to align one’s financial goals with one’s financial investments.  The final step is to maintain faith, patience, and discipline over long periods of time.  All behavioral attributes.

Always Be Debt Free.

Does being debt free make you wealthy? Paying off a home has always been one of the top financial goals of the clients I meet.  They often explain their parents told them this will lead to them having greater financial security.  But is it true?  “Time Value of Money” being one of the principles of financial management can be applied in this situation because the purchase of a home is a long-term debt.  Generally when the loan rate on a home mortgage is lower over a 15-30 year period than what you can expect to earn from a long-term investment over that same period, you may grow wealth faster by not paying off the loan sooner.   Loans not tied to an appreciating asset such as a home need to be considered separately on a case by case basis.  But simply carrying debt is not necessarily going to prevent one from increasing their wealth over time. 

Don’t miss out on your employer’s retirement plan match.

Payroll reduction for retirement savings in most company sponsored retirement plans today is automatic.  Most employers make matching contributions which create an immediate incentive for employees to start contributing immediately upon starting a new job. But is putting most or all your disposable income in an investment that will be tied up for 20-30+ years advisable?  Striking a balance between short-term and long-term savings is the real challenge to building financial security.  Who has not heard it’s a good idea to save for a “rainy” day?  As a rule of thumb, it is a good idea to have 6-12 months of income in a risk-free account if you are single.  For a married 2-income couple, 6 months may be just fine.  The objective is to avoid having to depend on credit cards, or loans from family members when an unforeseen emergency arises.  

Too often I have seen people withdraw from their retirement account simply to meet these unanticipated financial emergencies.  If under age 59 ½, the withdrawal is immediately eroded by penalties and income taxes.  All because there were little to no emergency savings.  It is certainly a great idea to capture employer matching contributions when savings is all about balancing competing needs.  Strike a balance if possible, between contributing just enough to qualify for all matching contributions from your employer until you build up your emergency savings.  The funds you by avoiding premature penalties and income taxes will go a long way in helping you build your wealth.  

In summary, for most people there are 3 competing needs for savings:  The short-term emergency need, an intermediate need for a down payment on a home, vacations, college educations, a car, and a long-term need for retirement income.  In a consumer-based economy, it is extremely hard to save for one of these needs, much less three or more. Here are a few steps to help start an emergency fund:  4-Steps to starting an emergency fund by Discover / Modern Money


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