Part of my role as a financial advisor is to help clients identify and avoid common financial mistakes. As I've observed over the course of my 27-year career, even the savviest investors can fall prey to these pitfalls if they're not careful.
Here are a few common mistakes investors make:
Letting emotions drive investment decisions: Jumping in and out of investments based on fear, excitement or other emotions sparked by short-term market fluctuations is not usually a sound investment strategy. Attempts to "time the market" can leave you at risk for bigger losses and excessive stress if longer-term trends do not work in your favor.
A better approach is to start by understanding your risk tolerance. Ask yourself how you would feel if the market were down 5, 10 or 20 percent. What would make you lose sleep at night?
A good portfolio takes into consideration both your desired rate of return and how you will react emotionally to market volatility. If you are investing in the markets, it is best to have a long-term outlook and to understand that ups and downs are part of the deal.
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Not paying yourself first: We tend to pay our bills and our taxes, and then spend or save whatever is left. A better approach is to consciously choose an amount to save that will help you reach your goals, and then save that amount before you pay your bills.
People do this all the time in their 401(k) plans, but it gets harder with liquid dollars. Pay yourself systematically into an investment account before you decide what to spend.
(Read more: Don't go it alone with 401(k) plan)
Making retirement lifestyle decisions in a vacuum: Most people worry about running out of money after they leave the workforce. Based on this fear, some fall into the mode of spending too little, and working longer than they need to, before retiring.
This overly conservative approach to saving is its own form of a financial trap. What's the purpose of having far more assets than you need at 90, if you're left wishing you had enjoyed your time and money more freely at a younger age?
Meanwhile, others spend too much in their working years and are left without enough to retire.
The solution is a solid, holistic financial plan with a probability analysis, to help you understand what you have and what you need in order to retire on your terms. Your homework is to gather information and analyze your spending needs.
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Understand the benefits of a home equity line of credit: If you have equity in a home, it may be inexpensive to apply for and open a home equity line of credit (HELOC).
A HELOC may be useful to have in case of emergencies. The mistake in waiting to apply is that if you become unemployed, have high debt or are otherwise less attractive to a bank, you may not qualify for the line at exactly the time you need it. Contrary to what many think, you only pay interest on the money you use. If there is no balance outstanding, there is nothing due.
Carrying credit card debt and paying it off with your tax refund: If you are getting a tax refund, you are likely withholding more than you need to during the course of the year.
Many investors do not realize that the purpose of filling out a W-4 form and choosing withholdings is to have the proper amount of taxes taken out, so that you end up near even at the end of the year. It is a tool the government gives us to adjust taxes, because everyone's situation is different.
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So, if you run up debt and pay interest all year, and then pay it off with a refund, the winners are the credit card companies and the government, which has had custody of your money all year. A better idea is to adjust your withholdings, get more cash on a monthly basis and pay off credit cards as they come due.
The key to remember with these and other common financial mistakes is that they're usually avoidable. A comprehensive financial plan suited to your unique goals, risk tolerance and time horizon can help you stay on the right track and steer clear of pitfalls.
Geri Pell, a certified financial planner, is president of Pell Wealth Partners in Rye Brook, N.Y. She is a wealth advisor specializing in fee-based financial planning and asset management strategies, and has been in practice for 27 years.
