Seven costly money mistakes and how you can avoid them
Without an income protection policy, you are exposed to risk
We all make financial mistakes, but some can cost you more dearly than others. Avoiding the following common and dangerous investment errors will help you make the most of your hard-earned money and grow it over the long term.
1. Following the herd
You go to a braai and everyone is buying bitcoin, so you feel you must also pile in, even though you have no understanding of cryptocurrencies. Though buying the latest and apparently greatest investment may satisfy your fomo (fear of missing out), it's misguided. You would be much better off getting a proper financial plan that covers all your bases. A proper financial plan should include setting up emergency savings to protect you from being financially vulnerable. It will protect your assets and your ability to earn an income, and will help you grow wealth over time so you can achieve your savings goals and provide for retirement. Make sure you understand the plan and all its components, including any investments. Having a plan and a financial adviser who acts as a sounding board whenever you make a financial decision will protect you from falling for fads and gambling with your money.
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2. Buying shares because it seems clever
Shares rise or fall rapidly for a variety of reasons, and buying because you think the share will continue to rise or has fallen to bargain levels is not a good idea. You need more information to justify a bet on a single share. When Steinhoff's share price hit rock bottom after CEO Markus Jooste's resignation in December 2017, for example, some people thought it was a good time to get the company for a song. But the professionals were still trying to figure out what was going on in the company.
Henry Faul, an adviser at Verso who holds the certified financial planner qualification, says a sound investment decision should be based on proper research coupled with a long-term strategy.
"By looking at a single factor only, such as price, you run the risk of letting the 'it's on sale bug' impair your judgment."
3. Falling into analysis paralysis
There are many investment debates, such as the one about active and passive investing and who is the best asset manager. Don't let these paralyse you into not investing and leaving your money in the bank earning an interest rate that may initially seem attractive but can be eroded over time.
The latest Long-term Perspectives report by Old Mutual Investment Group (Omig) illustrates how growth assets such as equities and listed property reward you over time. Over the past 89 years, the South African equity market delivered an after-inflation or real return of 7.3% a year, while cash delivered a real return of just 0.8% a year more than inflation.
While cash is appealing due to the low risk, it will take you a lifetime to double the real value of your money as opposed to just 10 years in equities, Omig says.
4. Chasing top performers
When markets are underperforming, it's tempting to switch from a poor-performing fund to one that has done well. But switching in response to short-term market conditions without doing proper analysis can jinx your investment over the long term, says Mthobisi Mthimkhulu, head of the direct & private client team at Allan Gray.
"To switch, you have to sell your units, which often locks in the underperformance of the fund you are switching out of. At the same time, the fund that you switch to may not be positioned to repeat its good performance. In effect, by switching you are selling and buying at exactly the wrong time," Mtimkhulu says.
5. Insuring your phone or car but not your income
If you buy an expensive item like a phone or a car, you insure it. But if you fail to insure your greatest asset, your ability to earn an income, you are risking losing something much more valuable.
"Without an income protection policy, you are exposed to a significant risk should you become temporarily or permanently disabled. When you're insuring your income, you're insuring your ability to pay not only your bond and living expenses, but also your investment premiums," says Boitumelo Mothoagae, a financial adviser at Liberty.
6. Seduced by scams
If it's too good to be true, it's probably a Ponzi or pyramid scheme. One of the features of a dodgy scheme, according to the Consumer Protection Act, is the promise or guarantee of an effective annual interest rate of at least 20% above the repo rate.
Keep the real returns you are likely to earn on your investments in mind when you consider deals and look for plausible explanations of why an investment you are offered could return way more than listed shares - there is no magic in investing.
7. Not exploiting tax breaks
Saving for retirement gives you a tax deduction, which means that if you're a taxpayer, your contributions to a retirement fund are partly funded by what you would otherwise pay in tax. For example, if your marginal tax rate is 35%, 35c in every rand that you pay to your retirement fund (up to the maximum amounts allowed) is a saving from tax. If you don't contribute to a retirement fund, that 35c would be paid to the government as tax.
In addition, your money will grow free of tax until you retire. Your pension will attract tax, but after age 65 you enjoy additional tax rebates.