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5 Common Mistakes to Avoid When Financial Planning

Updated: Aug 16, 2023

Financial habits now are crucial to your future retirement. In financial planning, we often see mistakes early on that lead to fewer opportunities later in life. Here are the 5 most common mistakes in financial planning:

1. Lack of Diversification

Diversification is important because it reduces risk inside your portfolio. Additionally, historic data tells us it also helps to create higher returns consistently. There are two different ways we often see a lack of diversification present. First is concentration of a specific asset relative to your other investments. This often takes the form of company stock. For example, receiving shares of stock as part of your benefits from your company and holding shares of the company inside your 401k may lead to concentration of company stock inside your portfolio. The second is holding too much of an entire asset class. If you look at the chart below and follow the Small Cap returns since 2008, you will notice a wide variety of returns, from 38.8% in 2013, to -20.4% in 2022. If your portfolio is overweighted in one of these asset classes, it likely will experience a high degree of different returns. However, a well-diversified portfolio with multiple asset classes shown by the line in the middle of the chart reflects more consistent returns year over year.

This chart shows the historical performance of different asset classes as well as an annually rebalanced asset allocation portfolio. The portfolio incorporates the various asset classes shown in the chart and highlights that balance and diversification can help reduce volatility and enhance returns.

2. Failing to Take Advantage of Employer Matches

Putting money into an employer retirement account, such as a 401k or 403b, is one of the best ways you can save for retirement. That’s because your employer may match the money you contribute to your account. For example, some companies match dollar for dollar up to 4%. This means that if you contribute 3% of your earnings, your employer will only match 3%. By not contributing 4%, you are leaving money on the table that your employer could be contributing on your behalf. To avoid this, ensure that if your employer provides a match that you are contributing enough to receive the full match.

3. Lifestyle Creeps

Another common mistake that people make as they get closer to retirement is allowing a creep in their lifestyle. Lifestyle creep occurs when your standard of living improves as your income increases. Former luxuries begin to become new necessities, which in turn increases your spending year over year. This is often seen in the years shortly before retirement where income levels are often at their peak levels. The downside of this creep is that once people reach retirement, their goal is often to maintain their previous lifestyle. However, many will run out of savings as they continue to live above their means. Lifestyle creep can also happen in the early years of savings. Most commonly, it is seen when young individuals receive a raise or get a higher-paying job. Spending habits begin to increase quickly, whereas saving levels are maintained or sometimes even decreased.

4. Not Planning Adequately for Health Insurance Costs in Retirement

Planning for health insurance costs is very important in retirement. If you want to retire before you qualify for Medicare (age 65), then most people have to go out to the marketplace to get health insurance. This is an expensive part of your early retirement years. However, with good planning, there are subsidies you can qualify for which provide significant tax savings. In order to receive these subsidies your taxable income has to be kept beneath a certain threshold. By controlling which investments you take your retirement income from, you can limit your taxable income.

5. Not Reviewing and Updating Your Plan Enough

Some people think a financial plan is a one-time event they go through to make sure they are on track for retirement. However, that normally doesn’t work. Instead, it should be a living document that is revisited multiple times throughout your pre-retirement years. Life changes often. You may have children, get an increase in income, lose a job, receive an inheritance, or find a new property you wish to buy. As any of these events happen, you should consult with your financial advisor and update your plan to see if any adjustments need to be made.

To avoid these mistakes, we recommend taking these steps:

  • Create a budget that works well for you and that allows you to save an adequate amount for the retirement you desire. Sticking to a budget decreases the risk of lifestyle creep and makes sure you are prioritizing saving.

  • Analyze your investments to ensure you are well-diversified which will reduce your risk and steady your returns.

  • Develop a financial plan to prepare for your future retirement and make sure you are saving enough now to reach your goals later. Work with an advisor who will review and update your plan with you as life changes and who will execute your plan well once you reach retirement.

If you are looking for an advisor to assist you in any of these areas, we are happy to help. Please contact us here or visit our website for more information.


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