5 Misconceptions You Probably Have about Personal Finance
As much as we wish it wasn’t true, there are some common mistakes we see over and over again that people make with money. But it’s not necessarily surprising - according to Standard & Poor’s Ratings Services Global Financial Literacy Survey, only 57% of U.S. adults are considered financially literate1. That means 43% of the United States population does not understand some or all of the basic financial concepts of numeracy, risk diversification, inflation and compound interest.
That being said, here are 5 misconceptions we’ve noticed time and again that people have about money, and why they’re wrong.
1. Believing You can Consistently Beat the Market
The thought of beating the market by hand picking stocks may be hard to ignore, but it’s improbable that you will ever be able to consistently outperform it. If no one can consistently predict the future, then no one can consistently beat the market! By going this route, you’ll be taking risks that you probably can’t afford.
Rather than fixating on beating a benchmark and focusing on short term success, you should instead put your effort into reaching a long-term goal. Whether it be providing cash flow for present and future needs, preserving wealth, or growing wealth with the goal of nominal return2 plus inflation – it is better to have a concrete long-term goal rather than attempting to beat the market day by day.
2. Selling at the Bottom of the Market
When the market goes down, we all feel it. Emotions run wild and investors begin to question their investments and convince themselves that it’s time to get out. The reason for this panic? They’re probably analyzing their investments too often. In a phenomenon known as myopic loss aversion, we know that those who constantly monitor their investments tend to regret losses two to two and a half times more than similar sized gains3. What’s the solution? Work with your financial advisor to create a financial plan based on logic, not emotion. Try to only follow up on your investments occasionally to track important factors such as your performance and make sure your asset allocation is in line with your risk tolerance.
3. Chasing Hot Stock Tips
Whether you hear it from a friend, coworker, or read it yourself in an article online – it can be hard to ignore the temptation of a “hot stock” to invest in. And while on occasion you may earn some quick money, making investment decisions based on hot stock tips is no way to earn money in the long run. Deliberate trading strategies generally center around, diligent portfolio management and market analysis – factors that generally don’t come into play with someone’s stock tip.
4. Thinking a Roth Contribution Adds to your Tax Bill
While many investors look at contributing to their IRA as a quick way to lower their tax bill, saying that a Roth IRA contribution adds your tax bill is not the case. In reality, your tax bill would be the same whether or not you contribute to your Roth – it will not raise your tax bill, it just doesn’t lower it. The trade-off here is when it comes time to withdrawal money from your Roth. You may be sacrificing upfront deductions, but when it comes time to withdraw you have the chance to get tax-free treatment on your retirement account’s income and gains.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
5. You Don’t Think You Need to Invest in Global Markets
Diversification may be an important part of managing portfolio risk and market volatility. It is the practice of spreading your investments around so that your exposure to any one type of asset is limited. This practice is designed to help reduce the volatility of your portfolio over time4 – the more major asset classes you leave out of your portfolio, the more you may potentially expose yourself to volatility. In terms of the global market, the U.S. stocks make up just under half of the market5. Global markets also behave differently than the U.S. market at different times6. So by leaving out international markets from your portfolio, it’s like leaving out a huge asset class with the potential to produce returns that are inversely correlated - that is when one market does well, the other tends not to and vice versa.
Recognize any of these mistakes? As financial advisors in Sarasota, FL and DeKalb, IL, with 30 years of financial planning experience, our team at Walsh & Associates is more than equipped to help you work towards avoiding these common financial planning misconceptions and mistakes. We’re here to help with your financial planning questions and needs.
There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to effect some of the strategies. Investing involves risks including possible loss of principal.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Securities offered through LPL Financial Member FINRA/SIPC. Financial Planning and investment advice offered through Walsh & Associates, a registered investment advisor and separate entity from LPL Financial.
1. Standard & Poor’s Ratings Services Global Financial Literacy Survey (2015) defines a person as financially literate when he or she correctly answers the literacy questions that measure the four fundamental concepts for financial decision-making—basic numeracy, interest compounding, inflation, and risk diversification.
2. A nominal rate of return is the amount of money generated by an investment before expenses such as taxes, investment fees and inflation are factored in.
3. Michael J. Mauboussin - More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) (2007).
4. Fidelity - Why Diversification Matters (accessed 2016) - https://www.fidelity.com/learning-center/investment-products/mutual-funds/diversification
5. Kiplinger -The Danger of Investing Too Heavily in U.S. Stocks (2015) -http://kiplinger.com/article/investing/T052-C023-S002-the-danger-of-investing-too-heavily-in-u-s-stocks.html
6. Vanguard - Global equities - Balancing home bias and diversification (2014) -https://www.vanguard.com/pdf/ISGGEB.pdf