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Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Saturday, March 26, 2011

Avoid These Basic Money Mistakes

Note: We wrote this article a couple of years ago for the Oakland Press. We believe these common mistakes need to be re-iterated, again and again. We’ve updated it to reflect some of our current thinking.

If you’re a new college graduate, it’s easy to get so anxious about investing that you fail to take care of some simple basics. And it’s not just twenty-year olds that make basic mistakes. We often have clients in their forties and fifties, or even older, who have failed to address the some of the following basic pre-requisites to investing.

First and foremost, everyone needs to establish an emergency fund. Financial planners typically recommend that an emergency fund equal to three to six months of fixed and variable expenses be maintained in liquid assets (cash or cash equivalents). This is to avoid having to liquidate investments at a possible loss as a result of an emergency. You can also afford to increase your insurance deductibles if you have more than the deductibles set aside.

If you are single or married with only one bread-winner, we recommend at least a six month emergency fund. If your household has two solid incomes, then a three-month fund may be adequate. Lack of an emergency often leads to excessive credit card debt. (Note: as a result of the recent “Great Recession”, we now favor a six month to twelve month emergency fund for two-income families.)

When you do establish your emergency fund, don’t place it in a bank checking or savings account earning a paltry 1% or 2% (or lower) return. Instead, you should find a solid higher-returning money-market fund paying close to the one-year CD rate.

Eliminating credit card debt is another basic pre-requisite before starting to invest. Interest rates of 15% and 16%, or more, are common for credit cards. It makes no sense to invest in a stock and bond portfolio paying at best a single digit return while you are paying nearly double that rate in monthly credit card interest. And, to earn a solid portfolio return requires taking on the risk of the stock market. Think along the lines that paying down credit-card debt is equivalent to earning a high-return with no risk.

Another common mistake people make is to give investing priority over addressing the most basic everyday risks that can be minimized with adequate insurance policies. Good medical coverage, disability insurance, life insurance, home and auto insurance are a must to avoid large losses that could forever impact your ability to achieve your lifetime goals. You might also want to consider long-term care insurance and/or umbrella liability insurance. (Note: long-term care providers have significantly raised rates recently and some have withdrawn from the market, altogether. Selecting a provider who will be around, “long term”, is more difficult than ever.)

Often our clients have no disability insurance. Your chances of becoming disabled on a given day are actually greater than your chance of dying. A long-term disability can seriously hinder achievement of your financial goals.

Besides credit card debt, other high-interest-rate debts should also be paid off before investing. Just as with credit-card debt, paying off other high interest-rate loans is equivalent to earning the associated loan-interest rate without taking on the risk of the stock market.

Finally, make sure you take advantage of employer 401(k) plan-matching contributions and stock-purchase plan discounts before dedicating other funds to new investments. Then, once you’ve taken care of the basics, when you do begin investing, get some unbiased help from a financial professional who has your best interests at heart.


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