28 March 2017

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Critical Financial Mistakes to Avoid

Personal Finance Mistakes ((familyfinance.in))
In this article, we are discussing Eight common personal finance mistakes people frequently commits. These financial errors are truly dangerous and needs to be identified and avoided. You need to know whether you are knowingly or unknowingly into any of these mistakes or not. If yes, necessary steps to be taken to rectify those errors and add quality to your financial world.

1.    No Budget, No Plan

This is the top mistake people frequently commit. Having no budget means not having control over your hard earned money. Some people think that, planning a budget is a boring and time taking activity. This is absolutely wrong.  A quote promptly says “most people don't plan to fail; they just fail to plan”. 

Having a budget is important in our daily life by considering below advantages:

-    Budgeting gives you control over your money to a great extent.
-    Keeps you focused on your financial goals
-    Makes you aware what is going on with your money
-    Helps you organize your spending and savings
-    Makes you decide things in advance
-    Enables you to save for expected and unexpected costs
-    Provides you with an early warning for potential financial problems
-    Helps you determine if you can take debt and how much
-    Enables you to produce extra money by avoiding late fees, penalties etc..
-    Budgeting also makes you to take control over your debts
-    Quality of your life would improve to a great extend

2.    No Emergency Fund

Emergency fund meant to deal with or tackle unexpected financial troubles that may occur in our life at any time. For example, sudden hospitalization, job lose etc.. Financial experts suggests that you should save at least 6 month worth of salary in your emergency fund and this fund must be kept as separate and untouched until and unless the arrival of any situation that meant for the use of this money.

Having an emergency fund is not a luxury but is a necessity. Here are some major advantages of an emergency fund:

-    You are able to financially back away from the edge of a cliff
-    Helps you prepare for life’s unpredictability
-    The emergency fund saves you money
-    Emergency fund protects your investments from stopping it prematurely
-    An emergency fund gives you the chance to be involved in other people’s emergencies
-    Emergency fund also stops you from borrowing high interest loans.
-    Psychologically, you will feel safe and can lead a peaceful and happy life.

3.    No Insurance

Many of the people I meet every day have little or no knowledge on the importance of having insurances. Life today is full of uncertainties and Life Insurances are the best bet to ensure your loved ones would continue to enjoy a good quality of life against any unforeseen event. Taking necessary measures in advance to protect self and dependents are mandatory. An important step in your financial plan should be protecting yourself and family by having adequate insurance cover. 

Here is why insurance is important in your personal finance:

-    Insurance protects you from unexpected, high medical costs
-    Ensures family members are financially safe
-    It can act as a protection against loans

Refer my previous article to know more about the types of insurances and how each would be beneficial for you.

4.    No Investments

Investment meant to protect the future of the person and family. Having no investments thus itself can be considered as a big mistake. There are several myths people have over this space such as, making investments required large amount of money etc. Making right investments are important to meet various financial goals set with short, medium and long terms. From ordinary savings bank account to stock market investments, investment world is vast and offering wide variety of investment options and opportunities to the people regardless the age and financial capacity of them.

Here are the major benefits of investing your money:

-    You can start investing with less possible amounts
-    You can have a mix of investment instruments suit to your various goals
-    You can select investment candidates based on your age, risk tolerance
-    You can take the huge benefit from the power of compounding interest
-    You will be a step ahead from everyone on financial independence
-    You will get benefited from tax free advantages such as dividends, tax free gains etc.

Keep an eye on forthcoming articles that would exclusively discuss on various investing opportunities.

5.    Only Debt Investments

Debt investments can be classified as Fixed Deposits (FD), various Term Deposits, Recurring Deposits (RD), Post office Savings and Monthly Income Plans, Public Provident Funds (PPF) and/or any investments that provide high security and fixed interest. Having only debt investments never satisfies your future financial goals. Debt investments such as FD’s all meant for people near to retirement life or have a definite near time goal such as marriage or purchasing home etc. There are several reasons why people preferring only debt investments, but one major reason among these is, fear on money lose and low risk taking capacity.

Here are some major disadvantages over debt investments:

-    Returns from the debt investments are very low
-    If the inflation is high, debt investors are the worst hit as the return from debt instruments may not be sufficient to cover the high expenses due to inflation
-    Debt investors may not be able to enjoy the benefits of investment diversification compare with money invested in stock market, mutual funds, real estate, gold and other alternate investments
-    As far as taxation is concerned, debt investments are taxed at normal rates of taxation and hence one cannot take the tax benefit from such investments
-    In fact if you withdraw before the agreed duration, you will be penalized
-    Liquidity is a major concern over most of the debt instruments that has certain lock-in period
-    With some debt investments, you can't touch your funds during the term's duration
-    Since the interest rate is fixed for the duration of the term, you wouldn't be able to take advantage of any cash rate increases.

Insurance plans such as money back or endowment plans cannot be considered as an investment. It would provide the subscriber with good insurance coverage during the tenure but the end pay would not be inflation adjusted.

6.    Over Diversified Investment Portfolio

Recalling the famous quote from legend investor Warren Buffett, he prominently said, “Wide diversification is only required when investors do not understand what they are doing”. The unavoidable risk from over diversification clearly exposed in his quote. An over diversified portfolio generally would be a place for improper allocation of variety of investment instruments through careless actions and ignorance. No doubt, over diversification will put the investor in deep trouble later by losing control over his or her act as well as not meeting any goals.

Properly diversified portfolio should be created with right mix of investment instruments in right proportion, purchased through good research. Such investment portfolio should be able to meet short, mid and long term goals set by the investor.

Here are the major disadvantages of an over diversified portfolio:

-    Over diversification makes the portfolio too complicated to manage
-    It is not easy to monitor and control every investments in an over diversified portfolio
-    Lack of focus and attention to your portfolio may results unexpected loses.
-    Over diversification results reduction or no investing quality, low returns, possible bad investments and may not be able to survive from market risks and inflation
-    High transaction fees would result below average returns
-    Over diversified portfolio results your capital is spread out thinly among the different investments and would results low impact of outperforming investments.

Diversification is one of the most important concepts in investment portfolio management, but proper diversification is the key.  While building your portfolio keep in mind the disadvantages of diversification in investing to help you achieve optimal diversification.

7.    Oversize Loans and Debts

A Dutch proverb says “Promises make debt, and debt makes promises”. Most of people in our society have one or more loan or debt. The truth is, when you are taking a loan, you are being a kind of slave to the person or organization from where you got the loan.  Loans may require meeting unexpected money requirements however, regardless the size, having a debt always impacts our personal finance in one or another way.  Controllable size of debts is always recommended by financial experts than borrowing money from all possible places.

Here are the notorious truths about loan or debt:

-    Bad debt is always against a perfect financial plan.  A person with huge debt is always in poverty.
-    The most obvious disadvantage of taking a loan is that you have to repay the loan, plus interest. Failure to do so exposes your property and assets to repossession by the bank.
-    Uncontrollable size of loans may lead you to take another loan to pay the first one.
-    Having excess debt than your re-payment capacity may badly affect your savings, investments and family life.
-    Borrowing money may impact the personal relationships to a great extent.
-    Frequent borrowers may put other people also into trouble by adding them as guarantors.

8.    Impulse Buying through Credit Cards

Wikipedia says “An impulse purchase or impulse buying is an unplanned decision to buy a product or service, made just before a purchase. One who tends to make such purchases is referred to as an impulse purchaser or impulse buyer”.  Credit cards are convenient and save time. It is easy to carry and avoid the requirements for carrying huge money with you. In the same time, it’s important to remember that a credit card is a form of borrowing. If they aren't used wisely, they can become a huge financial burden.
The biggest risk of credit cards is that they encourage people to spend money that they don't have. Such uncontrollable buying would put the person to huge debt and not easy to escape from such situations.

Here are the disadvantages of credit cards that need to be avoided:

-    Most credit cards do not ask you to pay off your balance each month.  While this may feel like “free money” at the time, you will absolutely must to pay it off.  The longer you wait, the more money you will lose with interest which accrues every day until you pay the balance.
-    The high interest rates and annual fees associated with credit cards often outweigh the benefits received.
-    Your purchase will suddenly become much more expensive if you carry a balance or miss a payment.
-    You will need to save your receipts and check them against your statement each month.
-    Low introductory rates may be an attractive option, but they last only for a limited time. When the teaser rate expires, the interest rate charged on your balance can jump dramatically.
-    Like cash, sometimes credit cards can be stolen. They may be physically stolen (if you lose your wallet) or someone may steal your credit card number (from a receipt, over the phone, or from a Web site) and use your card to rack up debts and even to bankruptcy

Being said, credit cards can make life easier and be a great tool, but if they aren't used wisely they can become a huge financial burden. If you do decide to use credit cards, remember these simple rules:

-    Keep track of all your purchases.
-    Don't spend outside your budget.
-    Pay off your balance on all of your credit cards at the end of each month.
-    Don't loan your credit or give out your credit card information to anyone but reliable companies.