When devising a financial plan, whatever its purpose may be, there are some common mistakes to avoid when it comes to executing the perfect plan.
Not having quantifiable, relevant objectives
Often people don’t have specific objectives for their investments, other than capital growth. Without establishing your objectives, how can you judge success?
Elements to consider when outlining your objectives are: the time period during which you are making your assessment, your benchmark, and whether this benchmark has any relevance in your life.
Inheritance tax sledgehammer
You could save extremely carefully, be prudent with your expenditure, manage your investments and keep income and capital gains tax to a minimum.
You could then find that, after all of this, HMRC takes up to 40% of your total assets once you have passed away.
In this case, the family of the person who achieved 5% per year growth on their portfolio throughout their lifetime would receive the equivalent of just 3% per year growth net of inheritance tax.
Careful planning can allow growth whilst mitigating the inheritance tax liability significantly and, if started early enough, in some cases it can be mitigated entirely.
Not having a plan
We can generally anticipate many important things that we are going to do or experience in our future. It’s possible to create a plan that allows your finances to work around your life and aspirations.
If you don’t have a plan, you may not have money when needed, or you may end up at age 90 with assets of £2 million.
This second scenario may sound ideal, but it could be viewed as £2 million of living that has been missed out on, or result in an £800,000 inheritance tax liability as mentioned above.
Not using allowances
The UK tax regime is very generous to investors. For portfolios under £10 million, it’s possible to generate total returns of up to 8% that are subject to between zero and 8% tax.
This isn’t via aggressive tax avoidance schemes (like moving money to Panama!) but through careful planning, usingISA, pension, capital gains and income tax allowances and structuring a portfolio in the right way.
Not using a partner’s allowance
Assets can often be transferred between spouses tax free, meaning the above allowances can be employed for both partners, potentially doubling the tax saving.
Right egg, wrong basket
To take advantage of this generous tax regime, it’s important to consider the type of return your investments will generate and how they will be taxed.
Placing income-generating investments like corporate bonds in your ISA or pension means you may avoid paying any income tax.
Investments like equities, which generate capital growth, can be held directly in an “unwrapped” account, allowing you to make use of your capital gains allowance each year.
Driving while looking in the rear view mirror
It’s tempting to invest in an oil exploration company having seen a 100% return in a month. However, as the investment cliché goes, past performance is no indication of future returns.
It’s human nature to believe that the future will be an extrapolation of the past and present. With investments it probably won’t. Markets are volatile. What goes up this month may go down the next and vice versa.
More eggs in baskets
Volatility isn’t the only type of risk, it’s important to spread your investments. Often people try to do this by investing through a number of different advisers or companies but this doesn’t necessarily spread risk.
If all of those advisers or companies are largely invested in blue-chip UK companies, then no diversification has been achieved. It’s important to look “under the bonnet” and to understand where the money is actually invested.
Comparing apples with oranges
When I first meet with people, they are often concerned that part of their portfolio is performing well, while other areas are doing less well.
On closer inspection you often find that, actually, performance has been very similar but the reporting periods are different. As already mentioned, markets can be volatile.
When comparing portfolio performance to an alternative fund or benchmark, it’s vital to use exactly the same dates. A single day difference could mean a 3% change in price, meaning any comparison is meaningless.
Comparing apples with pears
Comparing investments purely based on returns can be misleading.
An investment into a mining company could make you 100% return in a month compared to a couple of per cent for a diversified portfolio, but the risk associated with the individual share is astronomical in comparison.
Paying too much (or too little)
When it comes to fee paying, it’s important to strike the right balance. If you are paying too much, this can be a drag on asset performance.
However, paying too little can also have a negative impact on your assets as your wealth manager could be underperforming – after all, it is easy to find someone that can do a worse job for less money.
Don’t just look at your costs in isolation as this is meaningless, consider how your wealth manager is working for you.
Not knowing what you’re paying
Although it isn’t sensible to dwell on your costs alone, it is important to have an awareness of how much you are paying – believe me, most don’t!
Transparency of pricing within the industry has improved but still has some way to go. A very low headline figure can often hide a raft of underlying charges for transactions or administration. These can make the total cost much higher (sometimes several times higher!) than the price quoted initially.
My business is my pension
As we all know, pension planning is crucial as we can no longer rely on state provisions alone as a source of retirement funding.
If talking about pensions with business owners, they will often say, “why would I need to look at other pension plans when my business is my pension?”.
Quite simply, because it isn’t advisable to have all your eggs in one basket. If your business fails, the pension pot will be non-existent.
Consider the different options such as income drawdown for flexibility, an annuity for security and pension freedoms (which does what it says on the tin).
Chances are by exploring other options, you will find a route that works much more effectively.
My house is my pension
You have to live somewhere, so what’s the need to look at an alternative pension plan when you’ve got it all tied up in your property?
This can be answered by three questions:
- What if I need to downsize in the future?
- What if I decide to downsize but I can’t sell – how will I access my money?
- What if I can sell, but the value of my property falls?
Although the housing market has been buoyant, it doesn’t mean it will stay that way as recent data indicates. Remember, past returns aren’t an indicator of the future!
Buy (or gradually accumulate) and hold
Often, when you gradually accumulate, risks can be overlooked.
For instance, people with £100,000 or more in company shares accumulated through a save as you earn scheme may not realise how much they are actually investing in one place if they are parting with £500 a month over three to five years.
To combat this, the key question to ask is: if you had £100,000 cash, would you risk investing that big of a lump sum all at once?
Lifetime of money versus your lifetime
“I’m 75, I may only be around for another five years – I should put all my money in cash.”
This may be right, but if you are unlikely to spend it and your children are likely to invest post inheritance, you may end up with it sat in cash for 10 or 15 years for it to simply be reinvested.
If you know you won’t be able to spend it, don’t miss out on those last years of growth and income.
With such market volatility, the question on every investor’s lips is always “what if markets fall?”.
When, inevitably, markets do take a dip, the temptation can be to pull out. However, if you are investing for the long term, there is potential you might still receive good returns, so don’t act hastily.
Alternatively, greed can dominate investors thoughts whilst they constantly ask themselves “what if I miss out on returns?” or “what if I could make more?”.
Greed leads to inappropriate risk. To avoid this, it’s crucial to have a plan in place.
Knowing how much money you want to gain – whether it’s to live off after retirement or to reinvest elsewhere – is essential to financial planning.
With set targets comes appropriate risk – why make high-risk investments, targeting 10% growth, when you know you only need to target 3% to do everything you want to and still have money to spare?
Holding until it recovers
It may be tempting to hold onto a fund until it recovers. However, this decision needs to be caveated. If shares drop, what’s to say they won’t drop further?
A question you should be asking yourself is, “would I buy it now if I had the cash?”. Don’t automatically hold on without giving it further thought.
Listening to wild speculation
Of course, the way in which a lot of financial developments are heard is through the media. In the wake of Brexit, tabloids are quick to sensationalise every development in the financial landscape.
However, no matter how tempting, it is important not to take immediate actions as a direct result of what you hear. Speak to your financial adviser first, then act.