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The "Financial Planning Blueprint" Blog

  • Writer's pictureJason Flurry, CFP

How to avoid the three most common mistakes rookie investors make

When I first started in the financial services industry as a broker, the training we received was focused on transactions. Making the sale was everything because the only way anyone got paid was on the commission from that sale. Over time, the goal was to sell a variety of products to hopefully take someone from being a customer to becoming a client. In other words, if you own a stock, a bond, AND a mutual fund, you are more likely to stay with the financial advisor and his or her firm than if you just owned one investment, or one investment type through them. And that’s probably true.

So, it’s no wonder that brokers are taught to sell multiple types of products. And, if that broker is good is selling, he will probably persuade you to add two or three different types of investments to your portfolio in an effort to make your relationship with him more “sticky.“ After all, for financial advisor, having assets on the books is the key to building a good business. So maybe it’s not the proper way to say it when I described that type of client and advisor relationship as being “more sticky,” but you understand what I mean.

All right, so what is this have to do with being a rookie investor in making mistakes? It has a lot to do with it because once you understand the process that most financial advisors go through in their training, you have better insights into why you get the recommendations you receive from them. They’re not necessarily in your best interest, but in the broker’s best interest to encourage you to stay with them.

Mistake #1 That brings me to the first common mistake I see rookie investors make. Just like brokers, they focus on a transaction. The transaction is the means to an end, but without a clear objective, a transaction alone will not necessarily help you achieve your goals.

If your new investor, either because you’re young and you’re looking to make your money grow, or maybe you’re not as young as you used to be but for whatever reason you find yourself trying to figure out what to do with a lump sum of money, like you’d received from an inheritance, the sale of a business, or a divorce. In both situations, you may be very intelligent and even have a lot of experience in certain areas, but intelligence and experience alone won’t guarantee you financial success. You have to have practical, specific knowledge and experience to be successful financially and there are very few ways to shorten the learning curve.

So naturally, when you’re doing something difficult, especially with a lot of responsibility involved, it makes sense to seek the help of an expert. As I’ve discussed before, 90% of people who call themselves financial advisors may appear to be experts, but they’re simply little more than brokers looking to make a sale so they can keep their job, provide for their family, and keep their firm happy. That’s not to say they’re bad people, but they don’t have to put your best interest first in their recommendations. The only have to make recommendations that are suitable for you based on your age, income level, and financial status.

If you’re rookie, but want to avoid making the mistake that rookies do by focusing only on transactions, seek out the help of an experienced Registered Investment Advisor. You’ll usually find that the professionals that work at these firms are CERTIFIED FINANCIAL PLANNER™ professionals who are held to the highest ethical and professional standards in the business. They’ll help you develop a process you can depend on to build wealth, manage risk, and stay focused on achieving your goals, which is far more valuable than providing access to the markets to buy a product. You can do that now anywhere you have an Internet connection and there are even some places who can complete the transaction for you with no cost or fees. Maybe that’s why it’s so easy to make this mistake as a rookie. Easy access can be tempting, just like a freezer full of ice cream is when you’re hungry and on a diet. The transaction of opening that freezer door and taken advantage of what’s inside doesn’t serve you as well as the process you’re trying to follow by having an eating plan that’s aligned with your goals. Build a game plan and trust the process – and get the help of a professional coach who truly does have your best interest in mind if you need some support.

Mistake #2 The second big mistake I see rookies make has to do with taking on too much risk. I see this especially with younger investors were people say, “You’re young… You have plenty of time to recover from drops in the market.” Well, time is wonderful advantage and when I used to talk to students in high schools, I would tell them that they had something that the richest people in the world didn’t have and couldn’t buy with all their money. That was time. But, just like having access to the markets isn’t an advantage, having time without understanding how markets work doesn’t put you ahead either.

Financial markets will fluctuate and the degree to which they do fluctuate is measured by a mathematical term called standard deviation. You may remember standard deviation from your statistics class way back when, but basically standard deviation is a measure of risk and volatility. It’s important to understand how much volatility you have in your investment portfolio, because markets unfortunately don’t go straight up. They’re always periods of ups and downs and you need to know how much wiggle room you have built into your portfolio in order to keep you moving forward.

It’s okay to take a lot of risk if you’re getting enough return to compensate for it, but what I usually find is that people are taking way too much risk and getting far too little return. I don’t think it makes sense to take unnecessary risks at any age, and if you have a higher level of risk in your portfolio, you have to have higher returns over time to make up for the losses you’ll experience. I talked about that when I described the rate of return trap. Check that out when you have a minute if you haven’t already. It will open your eyes to see why taking on risk is an easily misunderstood approach that rookies, and a lot of other people, take that can cost them big time.

Mistake #3 The third big mistake that I see rookie investors make is focusing on saving a big pile of money for their future. Now I know this sounds a little bit crazy, especially coming from a CERTIFIED FINANCIAL PLANNER™ professional like me, let me explain.

There’s nothing wrong with accumulating a large pile of money when you’re thinking about your future, but that’s not the most important factor to your long-term success. What’s more important is the amount of income you can generate from that pile of money. And, you want to make sure that that’s income stream will last at least as long as you do so you don’t have to worry about running out of money before you run out of breath.

Your typical financial planner or financial advisor will often keep your focus on reaching some milestone number, like $2 - $3 million, for retirement - and that’s good. What’s often not so good thought is how that number was calculated. See, most financial advisors, and the financial media, subscribe to something called the 4% rule. It basically says that when you begin taking withdrawals from your investments, you don’t want to take any more than 4% per year or you may run the risk of running out of money. Again, that sounds very prudent and the 4% rule makes sense into you really think about it.

Old-time advice, like “don’t put all your eggs in one basket,” are based on sound principles. Not spending your principal and living off the interest is another one of those old-time adages that’s rooted in wisdom. But, is it true that you really can’t spend any of the money that you saved for retirement? Suppose you were successful in saving that $2 million or $3 million you set out to do. Is all of it off-limits for the rest of your life? The financial services community would tell you YES and use fear of running out of money as a reason to preserve those assets they manage for you each year – and charge you for each year you keep them on the books. So, while encouraging you to be financially conservative is in your best interest, keeping all of the money you’ve worked so hard to save under their management and control also serves their best interest and creates a lot of long-term security for their business model.

It is important to save as much as you can for the future, but rather than focusing exclusively on a number, like rookies do, figure out how much income you’re going to need to make work for a paycheck optional. Think through all of the things that will be required, like food, shelter, clothing, insurance, you know… the basic day-to-day stuff that has to be accounted for for the rest of your life. Then, also factor in the things that you’d enjoy doing, like travel, hobbies, charitable giving, and making memories with your friends and family. Those “core expenses” and “flex expenses” will make up your ideal lifestyle in retirement, so once you have a reasonable idea of what they may be, jot them down and figure out what they would cost if you are able to do them today.

Once you have a number, you can forecast out however many years you have until you like to be able to reach that goal and multiply your spending each year by inflation so that your future dollars will buy as much as your current dollars would. I typically use 2.5 to 3% as an inflation number to protect our private clients purchasing power over time.

Understanding this income number is far more important than making up some arbitrary savings number because this income number is your retirement lifestyle. Your real planning objective is to figure out how to provide for this number each year, adjusted for inflation, for the rest of your life. And, one of the best ways to get you from here to dead without worrying about money, is to create guaranteed, passive streams of income. That way, you don’t have to depend on the markets and adjust your lifestyle accordingly, missing out on vacations and things you really enjoy, because your account balances dropped. Like I said earlier, markets fluctuate and even conservative portfolios can lose value in a bear market.

Having a guaranteed income stream that’s not dependent on the stock market, the bank and interest rates, and the government provides so much more financial security than simply having a big pile of money saved up. An experienced investor understands this, but rookies usually don’t think things through to this level when they’re just getting started. They’re usually just following the advice of their advisor or the tips they read online about how to become financially independent. They never take the time to look at the rationale behind the advice to see if their best interest is really being served.

The REAL key to becoming a better investor The thing that makes all these common rookie mistakes so easy to make is that they all sounds so sensible in the beginning. After all, buying investments so that they’ll grow into a big pile of money over time so you can retire and be wealth is what being a smart investor is all about, right?

Well, sort of.

Truly being a smart investor involves following a proven process, managing risks, and taking steps to make sure your goals are being met independent of outside forces. Of course, there’s more to it than just having a plan and staying focused on your mission. But, if you do have a plan and you do stay focused on your mission, you’ll already be so far ahead of most of the people that your chances of success will improve tremendously. Finding a trusted Registered Investment Advisor who can help make sure your best interests are protected can take you even farther. And when you have a pro on your team like that, no one will ever know your rookie. You’ll be well on your way to winning the financial game and enjoying the journey along the way too.

If you are a rookie when it comes to managing money, or if you know someone who is, share this article with them. Remember too that there’s help available. If you’d like to talk to someone about your situation, you can request a free call with me here. We’ll help you make sure you’re on the right track so you can feel more confident and more certain your game plan is going to work. And, if there’s anything that needs attention, we can also help suggest ways to help improve your results. It’s a free offer in my way of saying thank you for being one of my readers.

If I can help in any way, please let me know. .


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