What are some of the Financial planning mistakes investors should avoid?
Financial planning is about creating wealth gradually and consistently. Investors must set their financial goals, save regularly, invest the amount saved, and protect their assets. With low financial literacy in India, investors either don't do financial planning or if they do, they make mistakes. Financial planning mistakes can cost them big in the long run. Today, we will understand financial planning and discuss a few common mistakes most people make.
What is financial planning?
It is a process of putting together a plan for your future. It is about how you will manage your finances and prepare for all the potential costs that you may incur in your financial journey. The first step in financial planning is evaluating your current financial situation. Next, set your financial goals and develop different strategies to achieve them.
Benefits of financial planning
There are many benefits of financial planning. We are listing the top ones below:
- Helps you with budgeting: Unless you have a financial goal, you won't see the need to save money. When you create a financial plan, you monitor your expenses more closely. It opens up an opportunity for you to lower your monthly expenses (wherever possible) and save.
- You plan for the future: When you start financial planning, you gain visibility of your future from a financial angle. You get a decent idea of how much money you will need ten years from now, and it helps you prepare for it.
- Prepared for emergencies: Emergencies come uninvited. If you are unprepared, it could drain you both financially and emotionally. Under financial planning, you prepare to handle emergencies by creating a fund equal to at least six months of your monthly salary.
- Peace of mind: With emergency funds and clarity about the future, you attain peace of mind. It is a beautiful feeling to have.
Top 5 financial planning mistakes to avoid
Starting late: We discussed above the importance of financial planning, and even after going through it, if you don't begin financial planning, it would be a big mistake.
What is the right age to start financial planning? The right age is NOW. If you have not started it yet, start it now. The sooner you start, the easier it gets. When you start early, you have a long time to achieve your goals - you can get more with less (thanks to the power of compounding). Most people start their financial journey but delay the planning part and lose precious years.
Fail to maintain an emergency fund: Step zero in a financial planning process is to create an emergency fund. Every individual must create an emergency fund equal to 6 to 9 months of their monthly expenses. Depending on your job security level, you can decide how many months of the fund is sufficient. You must keep your emergency funds in low-risk and highly liquid assets such as fixed deposits and debt funds. Avoid making the mistake of considering your mutual fund or stock investments as emergency funds. Also, never withdraw emergency funds unless there is a real emergency.
Taking too little or too much risk: Financial planning is about achieving your goals. To do that, you need to invest in different assets. However, investors either go too defensive with their investments or are very aggressive. Investors must understand their financial situation and, accordingly, pick asset classes. For example, an individual in his 50s and nearing retirement should not invest in equities (excessive risk) to get 15% returns. Similarly, someone in their 20s should invest in equity and not go too defensive by investing only in fixed-income instruments.
Not rebalancing the portfolio: Financial planning also entails having the proper asset allocation. When you create your portfolio, you allocate a different percentage to assets, which depends on your goals and risk profile. The first mistake around this point is that investors don't follow asset allocation.
Even if you do, with time, the allocation changes as some assets outperform while others underperform. Many investors fail to rebalance their portfolios regularly. It is important to reassess and minimize the risks in your portfolio. Rebalancing a portfolio helps investors stay on track with their investment strategy and must not be avoided.
Taking too little cover for medical and life insurance: Financial planning involves protecting yourself and your loved ones from unexpected life events. Many people under financial planning take insurance but take little medical and life insurance cover. You will not be there to regret taking low life cover, but your dependents will be impacted for sure because of your mistake. Adequate cover is essential - it ensures that your family goals are met in all situations. Your insurance should be enough for your family to maintain the same living standards even when you are not around.
These are some of the many financial planning mistakes people make in their financial planning journey. If you use financial planning, you can tackle more or less all your financial problems successfully. But for that, you must ensure you are not making the above mistakes.
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