In our previous issues, we have spoken about the various ways to plan your finances in the simplest yet most effective manner. As mentioned earlier, some diligence can go a long way in securing your financial future. However, there are certain common mistakes that can throw your investments off course. In this article we highlight the 10 mistakes that you must avoid in order to stay away from a financial mess.
1 Excess or deficit in emergency fund
The first common mistake made by several investors is that they end up having too much or too less money as liquid cash for emergency. Having too much money as cash results in an opportunity loss as this money can be routed for investments elsewhere to generate higher returns. And in an inflationary scenario as we are experiencing now, this assumes greater significance as high inflation reduces the effective return on your investment and a savings bank account/liquid fund ends up providing negative real returns.
On the other hand, too little in terms of emergency funds is also unadvisable as you need liquid cash for a rainy day. This is despite the refuge that a credit card can offer in tough times.
However, the biggest danger that comes with being short on ready cash is losing one’s job. If you do not have savings to cover two or three months’ expenses, you will find yourself in a tight spot which can be detrimental to your basic financial requirements.
2 Inadequate insurance
Underinsurance is a constant problem amongst Indian investors. The first aspect of this is life insurance. Investors tend to take the idea of insuring themselves casually. However, the lack of it is felt only when calamity strikes a family. As a thumb rule, we suggest that you should have a cover that is ten times your annual salary and in addition, it should cover all your outstanding liabilities.
The second vital aspect of insurance is with regard to health insurance and miscellaneous insurance covering your other important assets. As we have reiterated in our previous articles, health insurance is essential for self-employed/business professionals and the employed class of people. Similarly, it is better in our interest that we take a cover to protect our vital assets as well.
3 Credit card dues
Credit cards have provided the ease of a near cashless life, but they also have the potential to pull you into a dangerous debt trap. Credit card companies charge interest rates which range anywhere between 35 per cent and 45 per cent per annum. They are perfect tools for short-term financing where the credit cycle can be used to avail an interest free loan. However, most people end up paying only the minimum amount due which when repeated for a few months leads to a spiraling debt trap.
4 Multiple monthly EMIs
Any shop, credit card or bank offers the facility of paying for a particular commodity in an easy to pay Equated Monthly Installments (EMIs). Even though EMIs help spread out the financial burden, many investors inadvertently push themselves into the mode of paying multiple EMIs. This will put significant strain on your finances if you happen to lose your regular source of income. You should ensure that the total of all your EMIs should not exceed 40 per cent of your monthly salary.
5 Misleading claims
Many times, investors are contacted by greedy agents or brokers who push high commission paying investments products to meet their personal sales targets. They may promise impractically high returns or may underplay the risk factors associated with the various financial products. It is your responsibility to do a due diligence on the integrity of the agent and also the product offered by him/her.
6 Reading the fine print
It is imperative that you go through every detail/condition before investing in a product. This is especially true in the case of insurance policies. For example, if you do not read the exclusions in a health policy before buying one, it may land you in great financial stress in times of need.
7 Reading market sentiment
It is not timing the market, but the time in the market which is important. While making equity investments investors tend to get swayed by the general sentiment in the market. For instance, it was during the peak of January 2008 that investors were lured by euphoria in the market and made significant investments. In fact, most of the market pundits say that you should enter when there is panic in the market and sell when there is greed.
8 The 80C investments rush
In a rush to save tax, investors tend to get locked in non-performing products that are ill-suited and have stringent exit options. With proper planning, investments earmarked for section 80C can also be aligned to your goals.
9 Failing to make nominations
Nomination is one of the most crucial aspects without which the effectiveness of the investment remains incomplete. Nomination simplifies the process of realisation of investment proceeds in case of the original investor’s demise. If nominees have been appointed, they can produce basic documents, such as a death certificate, to access the funds. The absence of a nominee may require more documentation, such as the probate of will and certified list of legal heirs, before the investment can be transmitted or withdrawn. Nominees are deemed to hold the investment proceeds in a trust if it is disputed by legal heirs, pending a decision by the courts.
10 Not writing a will
Although most investors carry life insurance, nobody likes dwelling on the thought of death. So, the writing of a will is a task that is put off until later. Unfortunately, not having an updated will may pose severe difficulty to your legal heirs. They may not be able to access the funds when they need it the most. To paraphrase Ben Franklin, nothing is certain except death and taxes and both of these should be considered on an annual basis.
Through this list of common mistakes, we hope that you now have a clear understanding of all that must be avoided to keep away from financial woes.