While it is said it is fairly obvious how to build wealth, save more than we spend and invest, financial decisions we make are not always immediately obvious as the potential mistakes they can be. Here are a few to watch out for:
Keeping all your savings in a regular bank savings account
This seems like the correct thing to do. Save your money and keep it safe in the bank. While better than under the mattress this is in fact the riskiest move you can make with your money.
Inflation generally runs around 2% and right now the average easy access bank savings account in the UK pays around 1.15%. This means your money is losing value every day!.
If you’re savings are not earning more than inflation, your saved money will be worth less in the future. £100 today will not buy the same basket of goods in one year as inflation causes the cost of goods and services to increase.
The suggested approach to your savings would be to keep your emergency fund in a regular savings account, This is your safety cushion and you need to be able to easily access these funds in an emergency so think of the difference between the bank account interest and the inflation rate as your insurance premium! All other savings should ideally be invested consistently with when you wish to use the money for your goals. Short term goals, these are those less than 5 years, would be best met through a combination of your regular bank savings and some short term money market accounts.
Medium and long term savings are best suited to investing in the stock market and property.
Trying to time the market
It is very tempting to not invest in the market when all the news currently does is talk of the overvalued stock market and the next market crash.
Equally it is very challenging to stay in the market when everything seems to be going pear shaped. The Global financial crisis in 2008 when the US stock market dropped close to 40% is a very real example of this.
While it is a given that markets will go up and down. It is virtually impossible to predict when this will occur.
Save yourself the stress and anxiety of trying to time getting into the markets and equally getting out. Get in the market as soon as you have available funds via a ready made portfolio that matches your risk profile on one of the robo-adviser platforms, such as Vanguard, Nutmeg or such or start a DIY portfolio by buying index tracking funds to create your own portfolio. Leave your portfolio to grow. Simple as that.
Lack of diversification in investments
Diversification is an approach to limit the risk to your investments, much like the old saying “not keeping all your eggs in one basket.”
Although some experts argue that diversification is for those who don’t understand what they are doing when they invest, I am one definitely a “non understander” then because I know that I don’t have a magic crystal ball and single investments are extremely risky. The potential gains are high but so are the potential losses as you can lose your entire investment if that asset hits the wall.
Diversification is not about eliminating risk totally from your portfolio but given that you have invested across different asset classes, different industries and different jurisdictions your return is no longer dependent on one asset performing. It is dependent on a portfolio of assets and history has shown different assets respond differently to macroeconomic events. This means when one asset class is down another will be up. This will smooth your return over time although it does also dilute it slightly, but this is a small price to pay for limiting the overall risk of your investments.
Spending the maximum we have been approved for on a mortgage when buying a property
It is so exciting and somewhat validating of our success when our mortgage application comes back and we are approved at a level we never expected. In the excitement we might be tempted to stretch for that house which is more than a little outside our budget but must be ok because our mortgage limit says we can afford it.
This is a big mistake and one I can confess I have been guilty of, and not once but twice. Clearly I am a slow learner! What I can tell you is there is nothing more stressful than being a prisoner of your mortgage payment, stressed beyond measure, no additional disposable income and in a nail biting sweat every time there is an interest rate decision that may mean your monthly payment increases.
Work out what monthly mortgage payment you want to pay each month. Apply some stresses to this by testing how much it would increase if interest rates were to rise by a significant amount. Check that you have included all the other costs of owning a house in your budget. Remember there is no landlord to call when the boiler breaks down, the plumbing stops working or some other house repair pops up.
I can say I got totally swept away by the romantic allure of owning the dream house, (which of course meant the more expensive one). When I woke up to reality there was nothing left of the romantic vision and owning a house you cannot afford is more of a nightmare!
Assuming house values will always go up
Our parents, the press and a large proportion of our friends will tell us we cannot go wrong with bricks and mortar. Actually they are factually incorrect.
House prices rose by 1.4% in the UK in 2019 according to Nationwide Building Society. This is slower than wages and inflation so in “real terms” house prices are falling. Maybe great if you are looking to get on the housing ladder, not so great if you overextended yourself in buying a quick “flipper” with the belief that property prices would rise and you could make a fast profit.
Is property a bad buy then? No, it can be a good addition to a portfolio by adding diversification, either through owning physical property, which requires a large amount of capital and is less liquid when it comes to selling it, or through investments in property owning trusts on the stock market, a cost effective and relatively easily saleable asset.
The point to note here is just like any other assets property prices go up and come down. Knowing this and accounting for this possibility in your assessment of the transaction puts you in a much better position to ensure you are getting a workable deal.
Mistakes are good learning experiences but hopefully armed with the knowledge of the more common ones you can be lucky enough to avoid them!