Everything we achieve in life begins in our minds. It’s true that as Walt Disney said, “If you can imagine it, you can do it.” But it’s also true that our minds can create obstacles to reaching our goals and objectives. This is absolutely true when it comes to financial planning and investing.
In my book, You Can Retire Sooner Than You Think, I discuss some common psychological miscues to avoid as you chart and pursue your financial future.
Underestimating how much you need to save. This is perhaps the most dangerous pitfall, and it’s incredibly common. We either don’t do our homework or we sell ourselves on some rosy scenario when setting our target for funding our retirement.
If you don’t have a savings goal, sit down this weekend and put a sharp pencil on it. Start by discussing how you envision your retirement. Will you travel? Buy a beach house? Start a small business? Hang out at home reading and gardening? Will the kids and grandkids need a financial hand?
Think, too, about the hardest of questions. Statistically, we are living longer. You could be retired 30 years. That fact must be factored into your savings goal. Consider health issues as well. How might they impact your financial situation?
Chasing Quick Profits. Asset bubbles are an alluring and deadly phenomenon. Soaring tech stocks, condos or precious metals create a siren song that can lure even smart investors off their well-thought-out path of diversified investment. After all, when the herd starts running after something and “everybody” has a story of huge profits gleaned with ease, we don’t want to be left behind, right? Then the bubble bursts, taking everyone down in a pop flash.
When the drumbeat starts for some hot asset of investment, take a breath and keep your eyes on the real prize. Remember that you are running a marathon. Sprinting down a side road in pursuit of a quick profit is an energy-sapping distraction that likely won’t improve your performance.
Benchmarking. This is the phenomenon of always seeing something greener on the other side of the investment fence. “My portfolio was up 8% this year, but I see where this European stocks were up 16%. Maybe I should move a chunk of my money into that area.”
This sort of thinking will run you ragged and lead to constant disappointment. Why? Because this sort thinking is often based solely on past performance of an asset. The investor fails to examine its fundamentals to see whether that awesome return is typical or possible to replicate going forward.
Again, when tempted by the fruit of another, remember that you have a well-crafted plan in place that should not be upended on a whim. If you think this juicy new asset category might be additive to your strategy, do your homework – all of it – before adding it to your portfolio.
Anchoring. It’s easy to build an emotional attachment to a stock, either because we’ve held it a long time, or because we have a deep understanding of it — perhaps because we work for the company. But a stack isn’t necessarily a safe or smart investment just because we are familiar with it. This is another example of emotion trumping sound investment thinking.
Divorce. I’m not saying you should stay in an unhappy relationship for financial reasons, but ending a marriage is incredibly costly. Too many people simply rationalize this reality away in their haste to escape a bad relationship. You, in essence, cut your net worth in half. The later in life this happens, the tougher it is to recover. There’s a reason that most of the high-net-worth individuals profiled in The Millionaire Next Door have never been divorced. What’s more, from an emotional standpoint, based on research for my book, the happiest retirees are married.
Skipping over fees. Fees can put a serious dent in your investment returns. As you build and tweak your portfolio ask questions and read the fine print to make sure you are fully aware of all possible fees, which can include marketing fees, surrender penalties, operating cost fees, brokerage trading commissions, and more.
Sacrificing Liquidity. In our pursuit of returns, we sometimes fail to consider other critical factors, like liquidity. While you should ideally be invested for the long-term, there may come a time when you need to tap the money you’ve invested to meet an urgent need. Some investment products, including annuities, can lock up your money for 5 to 15 years, either because there is no market to resell the asset or because hefty penalties are imposed if you sell it.
For more on the most common investment pitfalls, and how to avoid them, check out my book, You Can Retire Sooner Than You Think.