Everybody in his or her life commits mistakes knowingly or unknowingly. The repercussions of such a mistake could be non-bothering, but sometimes it can play havoc at a later stage. Financial mistakes are blunders that can create big problems in life if it’s not resolved immediately.
Suppose Mr. X has planned for a retirement at an age of 60 years, and by mistake he forgot to consider the erosion of money value due to inflation. What would be the outcome at the time of his retirement? The retirement corpus would be peanuts in the hand.
So let’s discuss important financial mistakes, which should be avoided before it ruins the life.
Borrowing without need
Banks and financial institutions are very eager to lend money. They look for somebody to borrow it and pay them some interest. Nowadays, many financial borrowing instruments are launched to trap the customer and make them habitual of such tools. Zero interest credit cards, low interest soft loans, interest free car loans and free insurance with debit credit cards are some of the confusing and unnecessary financial products which are cutting the pockets of an investor. People go to a bank for opening the savings account, and their sales person attaches an offer of free credit card with the new account. Usually, people accept these offers in excitement and then find the associated charges to be very high hence pay high bills in the future. Such offers should be firmly rejected, and a person should focus only on the actual requirement.
Living on single revenue source
Sometimes people underestimate the uncertainties that lie in the future. What one earns today could seem sufficient until there is no dramatic halt in the source of earning, but a small bad event can change the whole financial planning. What if one looses the job and doesn’t get another in appropriate time or what if one suffers heavy loss in the business? The answer for such an uncertainty is that it is always better to add some variation in the source of revenue. It not only minimizes the risk but also increases the income. A businessman can add another line of work that could also allow some diversification. One, who is into a job, can start part-time self-employment work or online business that needs less direct involvement.
Not Creating an Emergency Fund
Creating an emergency fund is like providing insurance to sudden financial setbacks. In the absence of an emergency fund, a person would feel handicapped in time of emergency monetary requirement. It may happen that one receives salary cheque late due to unavoidable reason, and then he/she can easily handle such a situation by using the emergency fund. One should keep aside at least 20% of the annual salary separate as an emergency fund. Plan for it.
Underestimating the Time Value of Money
Financial planning and saving for the future are a common process, and its importance is understood by most of the investors. While setting a financial goal, it is very important to adjust the target with the time value of money. Inflation erodes the value of money of time over a period of time. One who sets the financial goal on the basis of current requirements and present value of money then he/she is sure to face steep monetary crunch in time of actual need in the future. So it is important to keep updating the investment with value erosion due to inflation and review future plan as per updated status. It is always better to project the future needs after adjusting the inflation regularly.
Living in Debts
Spending more than what you earn is a very dangerous proposition. An extra amount spent over what is earned would lead you to a debt trap. Debt trap is a situation where one creates new loan to pay the old one. It goes on continuously until one becomes a defaulter and finally an insolvent. So, debt in time of need is not a bad thing but a habit of living in debt is very risky.
Underinsurance is a situation when the total insurance claim receivable by a person is not sufficient to pay out the losses incurred. It can also be defined as a condition when a lesser insurance claim received then required for replacing the lost item. Once the item is lost then one cannot go back in the past and make good the mistake for increasing the insured amount. Therefore, it is very important to review the insurance value from time to time. The asset value and earning capacity keeps on growing over a period of time and a gap in insured value to the current market value of an asset is very certain if it's not reviewed timely. Additional insurance should be purchased to cover the complete value of the asset whenever it's required.
The financial mistakes can have various legal and monetary consequences. Above-mentioned points is just a glimpse of some prominent mistakes. We should always be observant to avoid any kind of financial mistakes because outcome can bring huge austerity in the life.
About the author
Amit Sethi is an MBA (Fin) graduate and a Financial Consultant. He has spent 8 years in Equity research and Stock broking sector. He can be reached at firstname.lastname@example.org
Courtesy: Investment Yogi