5 Investing Mistakes That New Investors Make

With a little knowledge, or some help from a financial advisor, many of the investment mistakes new investors make can be largely avoided.

But most people aren’t aware of the psychological barriers inhibiting their ability to invest successfully in the first place until it’s too late.

Here are the five investing mistakes that most new investors make and how to avoid them.

Relying on Investment Advice from Friends & Family

Your friends and family may have the very best of intentions, but that doesn’t make them qualified to give you advice for investing your wealth.

What’s worse is because we trust our friends and family so much, we are more susceptible to blindly following what they have to say. Which can open us up to misinformation and sometimes downright bad investment advice.

Only a trained, financial professional can analyze your particular financial situation and provide objective advice that’s based on research, facts, and prevailing wisdom.

Trying to Do it On Your Own

Education and active participation in your investment strategy is positive, especially when combined with the financial expertise of a trained financial advisor.

For some people, the DIY method works, but only because they typically treat it as a second profession.  Trying to do it on your own when you’re not sure what you’re doing can lead to costly consequences.

Instead, consider hiring a financial advisor.

Financial advisors not only advise you on how to invest, but how much and when. They’ll make investment recommendations based on your total financial picture, ensuring that you invest where it makes the most sense for you and your personal situation.

Ignoring Risk or Not Understanding Risk

Nothing in life is certain, especially investing.

Every investment comes with risk, some more so than others. A financial advisor will make you aware of the level of risk associated with investments and minimize your exposure to risk as best they can.

Diversification is one such way that a financial advisor minimizes your risk by spreading investments across asset classes so that your eggs aren’t all in one basket.

Not Arming Yourself with Financial Education

Even if you do end up hiring a financial advisor to help you manage your investments, it’s still good to have a general understanding of what type of investments are out there.

Increasing your financial literacy will only help you ask the right questions.

Not Understanding Your Money Personality

One of the first things a financial advisor or even a robo advisor will ask you is how you feel about risk. Your tolerance for risk is a major determining factor in how our investment portfolios are constructed. 

Risk tolerance is determined by a few factors, such as how close you are to retirement and what you are trying to accomplish with your wealth.

Your money personality is how you feel about money, what causes you the most anxiety, and what will cause greater financial security for you.

Knowing your money personality will help a financial advisor to build an investment strategy that most closely aligns with your needs and according to your psychological comfort zone.

Dealing With Loss and Having a Plan

As a financial planner, I’ve seen grief come from a variety of situations: the death of a loved one, separation from a spouse, loss of a job, changing jobs, a serious illness, and even the death of a pet.

When dealing with the death of a spouse specifically, the grieving process takes time and there is no “normal” time frame for grieving.

Whatever your grief experience, it’s important to be patient with yourself and allow the process to happen naturally. And while there is no right or wrong way to grieve, there are healthy ways to cope with the challenges of the loss.

Get support and take care of yourself

One of the most important factors in recovering from the loss of a spouse is having the support of other people.

You should lean on the people who care about you, even if you take pride in being strong and self-sufficient. Embrace loved ones, rather than avoiding them, and accept the assistance that’s offered.

When you’re grieving, it’s more important than ever to take care of yourself. Combat stress and fatigue by getting enough sleep, eating right, and exercising.

You can try to suppress your grief, but you can’t avoid it forever. In order to heal, you have to acknowledge the pain. Trying to avoid feelings of sadness and loss only prolongs the grieving process.

If you find yourself turning to unhealthy ways to cope with the pain, you should contact a therapist for professional help.

Have a plan

I have found that having a plan in place greatly reduces the amount of stress in the event of a loss of a loved one, resulting in more time available to grieve and less time worrying about stressful decisions.

My goal as a financial planner is to develop a comprehensive financial plan that covers all aspects of a client’s life, and I make sure that they are prepared for a sudden life-changing event such as the loss of a spouse.

If you don’t have an expert to assist in creating a plan, you will want to make sure you have at least the basics in place before the death of yourself or a loved one.

Below are some common things you will want to consider before and after a loss.

Before:

  • Use a password management system – Begin using a secure password system to manage your various online accounts, email, and other online services. A summary of these services can be accessed at this link: Password Managers.
    If you are not comfortable with online technology tools, ensure your various passwords are complex, secured, and accessible to family members. This will also help ensure that you or your family is not locked out of access to important accounts and services online in the event of death or disability. 
  • Create an estate plan – Contact a trusted estate-planning attorney to help you draft the documents needed to ensure your wishes are carried out in the event of your death, and that you are well cared for in the event of your disability. 
  • Plan your funeral – Your family will be in a fragile state emotionally when you pass away. It may be difficult for them to negotiate funeral costs at that time. Solve this issue by planning your funeral today. You can even prepay for your funeral if you want. Visit a local funeral home to discuss it.

After:

  • Get multiple copies of the death certificate – You should go to the city clerk’s office and get certified copies of the death certificate. It is best practice to get numerous copies because of the various institutions that require them in order to release funds or close accounts.
  • Decide what to do with life insurance proceeds – If you work with a Certified Financial Planner (CFP), you should have a general idea of what you will use the money for and where to hold it. But many times it can be overwhelming to receive a large check in the mail. You could deposit it in a checking or savings account, but remember, your FDIC coverage is now only $250,000 per institution.
  • Notify Social Security –  The agency can put the deceased person on the Social Security Master Death Index. This prevents would-be fraudsters from collecting the loved one’s Social Security payments. It also helps stop identity thieves from opening accounts in the name of the deceased individual, because the person’s credit reports will be flagged.
  • Transfer accounts – You’ll want to transfer accounts from your loved one’s name into your own. This not only covers bills such as the power, electricity, and water, but also financial accounts such as bank accounts, IRAs, 401(k)s, etc. Since every state has different mandates, be sure to check what type of legal filings, if any, are necessary in the state in which a family member has died, as well as any state where the individual owned property. Your CFP and estate attorney will be incredibly valuable during this transition.

Are your spending habits making you happy?

It is safe to say that most of you are familiar with the concept of “keeping up with the Joneses”. If you haven’t, here is how one source eloquently puts it:

“Keeping up with the Joneses” is an idiom in many parts of the English-speaking world referring to the comparison to one’s neighbor as a benchmark for social class or the accumulation of material goods. To fail to “keep up with the Joneses” is perceived as demonstrating socio-economic or cultural inferiority.

The desire to compare ourselves to our peers is part of human nature — we wouldn’t have sports, corporate ladders, or eating contests if it weren’t.

But measuring our own financial success against that of our peers and letting their spending behavior influence our own can spell major trouble for our finances. And the amount of consumer debt in our society is evidence of this fact.

It seems as though more and more of us are willing to pull out the plastic without regard to our budget. As Will Rogers said, “Too many people spend money they haven’t earned to buy things they don’t want to impress people they don’t like”.

So what can we do to pay less attention to how the Joneses are doing and focus instead on our own financial health and the things in life that will truly make us happy?

Stop comparing yourself to others

Since we never know what anyone else’s financial picture really looks like, it’s important not to see their apparent success as our own failure.

Remember, we don’t know their story and it’s highly possible that our peers are living beyond their means.

Learn to live within your means

Regardless of our income, without a little discipline, it is easy to spend all of it on frivolous things. And if you haven’t built financial margin into your life, one little hiccup in income could result in losing those things and possibly more.

Nearly eight out of ten families in the United States are living paycheck to paycheck. That means one missed paycheck and the bills are going unpaid.

I am willing to go out on a branch to say that the Joneses are likely living paycheck to paycheck and are financing their lifestyle in a way that puts them in danger of losing everything. In turn, the Joneses are likely just as stressed about money as we are.

To relieve some stress, start by tracking spending habits to figure out where money is going. You might be surprised at what you find. Then take action to improve your situation.

Find your own happiness

Don’t let anyone else dictate what should make you happy. Material possessions cannot fill an empty heart.

Instead of spending mindlessly, put your energy into your family and your relationships. That’s where the real value is.

Pension Benefit vs Lump-Sum

If you are fortunate to have an employer guaranteed retirement benefit in a post-pension era, it’s likely you have been offered the option of a lump-sum payment or monthly benefit.

You may like the peace of mind that comes with the payments since you are assured a monthly income for life, but the lump-sum option gives you the opportunity to invest your own retirement funds, can be withdrawn on your own schedule, and can be left to your heirs after your death.

Should you take the pension or accept the buyout? The answer to this question depends on a number of factors that we’ll explore below.

Pension and Lump-Sum Example

To help illustrate the point, let’s assume you are currently a 45-year-old female and your employer is offering to pay you $2,045 per month as a single life annuity starting at age 65 through the remainder of your lifetime (your official life expectancy is around age 88). Or they are offering to pay you $145,000 in a lump-sum today.

What the Math Says

The first step is to calculate the rate of return that would make the two options equal to each other. You’ll need to use an internal rate of return (IRR) calculator to do this.

I’ll spare you the mathematical details and skip straight to the good stuff. The calculation shows that the internal rate of return is 4.72% at life expectancy. This essentially means that $145,000 growing at 4.72% per year while withdrawing $2,045 per month starting at age 65 would last for 23 years, with nothing left over — the equivalent of the monthly pension.

The longer you live, the more pension payments there are and the higher your investment return would have to be to match the pension by investing the $145,000 lump sum. Conversely, if you don’t live very long, even a return of 0% or less would be better than taking the monthly pension.

The rate of return needed on the lump sum to match the monthly pension

As you can see in the chart above, the required rates of return to replicate what the pension provides is fairly modest in this scenario.

To secure the pension payments to age 100, you would need your lump-sum portfolio to generate an average annual growth rate of around 5.30% — which is certainly achievable with the right portfolio.

If it would take an 8% to 10% rate of return on the lump sum to give you a cash flow equal to the pension payments at your life expectancy, then the pension might be a better option.

On the other hand, if a low rate of return could provide that same cash flow, you might want to go with the lump sum.

You’ll have to determine if the rate of return in your particular situation is attainable given your tolerance for market risk and other investing factors. This is something a financial advisor can help you figure out.

Other Things to Consider

While the pension payments offer some nice longevity insurance if you live past life expectancy, you’ll also need to consider the impact of inflation on the $2,045 per month payments.

Using a simple inflation-adjustment calculation, the pension payments may only equate to $977 in today’s dollars 20 years from now with 3.76% inflation, and will quickly degrade from there. This simply means that your money won’t go as far to purchase goods and services.

Value of the monthly pension after inflation

You’ll also want to keep your beneficiaries in mind when deciding between the two options. With the pension, there may not be any money that passes to your chosen beneficiaries. The lump-sum offers a little more flexibility when it comes to how the money flows to your heirs.

Another thing to consider is the financial health of your employer. If you have any concerns about the longevity of the company — or their ability to manage the pension funds — you may put more weight into taking the lump-sum now.

Finally, you’ll need to do some self-reflection and determine if you have the discipline it takes to actually make the money last throughout your retirement.

If you’re the kind of person that will use the lump-sum to take a vacation, maybe taking the monthly payments makes the most sense from a behavioral standpoint.

The pension payments provide consistent cash flow that will help with budgeting decisions and eliminates the possibility of using up that portion of your wealth while you living.

There is no one-size-fits-all solution for everyone. The specific terms of the deal and your individual situation both play a role in whether you should accept the lump-sum or wait for a monthly pension check at retirement.

Before deciding which option is right for you, be sure to work with an advisor who will provide you with the facts you’ll need to make an informed decision.

How To Find A Tax Preparer

A big shout-out to Stacy Antrobus for this week’s post idea! Thanks, Stacy!

As we make our way through yet another tax season, wading through W-2’s and 1099’s, you may find yourself feeling slightly overwhelmed.

If so, you’re not alone.

More than half of all taxpayers feel the complexity of tax laws and forms makes preparation too difficult and time-consuming.

Considering the multitude of tax preparation software and online resources available to aid taxpayers in filing their own return, at what point does it make sense to use a professional tax preparer?

And if you decide to use a professional, how do you choose the right one?

To self-prep or not to self-prEP

While there isn’t a black and white rule for determining if you should or should not self-prepare, there are certain situations in which you may want to get help from a professional.

Major life changes, such as marriage, divorce, inheritance, changes in your family or getting a new job are among the most common.

If you are self-employed, you may need the guidance of a tax professional when it comes to deciding what qualifies as business expenses and how to minimize your tax burden.

Generally, if you have complicated financial affairs or simply don’t want to deal with tax season, help from a professional is likely needed.

The U.S. Federal tax code, along with the supporting information, contains over 70,000 pages! Each one of them is a reason to ask for some help.

Who do you choose?

If familiarizing yourself with 70,000 pages of the tax code isn’t for you, your next step is to determine what kind of professional to use.

Tax professionals fall into a few different categories:

  • National tax services: H&R Block, Jackson Hewitt, etc. These services are best for taxpayers with relatively simple tax preparation needs.
  • Enrolled agents (EAs): Federally licensed individual tax practitioners who have passed a 2-day IRS-administered exam. They are qualified to handle tax preparation at various levels of complexity levels.
  • Certified public accountants (CPAs): Tax professionals who have a bachelor’s in accounting and have passed a grueling series of tests to gain the licensing. They prepare returns, can represent you in the event of tax problems, and can assist you with tax planning.
  • Tax attorneys: Lawyers who specialize in tax planning.

The fees charged by professional tax preparers can range from as little as  $100 to $1,000 or more, with fees largely driven by the complexity of your situation and the sophistication of the tax strategies employed by the professional you are working with.

From my own personal experience, I generally find that the majority of people utilize the services of a CPA.

Even though you are paying these professionals to help improve accuracy and minimize your tax liability, always check your own completed tax returns carefully before signing them.

You are ultimately responsible for the accuracy of your return.

To reduce the chance of error — particularly if you are self-preparing —  you should become familiar with basic tax principles and regulations, check all documents for accuracy, and request an explanation of any items on your return that you don’t understand.

How do you choose?

Since you are legally responsible for your tax returns, it is important to choose the right person to prepare them for you.

Here are a few things you can do to help you find the best tax preparer to work with and ensure your tax season goes as smoothly as possible:

  • Make sure that a prospective preparer has a PTIN – which all paid tax return preparers are required to have. These are issued by the IRS and you can search their database for any preparer who has one.
  • Make sure they don’t have disciplinary actions and check the status of any licenses they hold.
  • Be sure to compare fees and make sure you understand and accept the fee for services rendered. Never work with a preparer who asks for a percentage of your refund.
  • A good preparer will request records and receipts and ask you about your income and expenses to get a feel for your tax situation. If a preparer offers to file your returns without seeing your W-2 or other records, do not work with them!
  • Never use a preparer who asks you to sign a blank tax form. Never sign a document until you are able to review and verify its accuracy.