How much do you really know about your money? With all the financial stress we encounter, it is very tempting to over-delegate control of your money to a financial professional. In the short term, it often feels like a huge relief, a weight off your shoulders, a burden for someone else to manage.
It’s the same feeling I always get at the mechanics when I drive the car in, looking for a quick fix and a ride home. The last thing I want is to actually learn how the car runs, though I’d probably be tens of thousands of dollars richer if I did know some fundamentals. I’m sure I’d also manage to avoid a steady stream of problems by actually maintaining my car.
The problem is that there are no checks and balances when you over-delegate important aspects of your life or your money. When we surrender control, we are much more likely to be a victim of fraud or negligence, and we stop making decisions based on our life goals. Instead we put ourselves in a position of reacting to plans made on our behalf and letting our financial situation dictate our life goals rather than the other way around. There are seven concepts you can commit to memory and practice regularly in order to effectively manage your finances. These won’t guarantee financial success, but they will dramatically improve your odds of achieving your financial goals and avoiding financial disasters:
Know your advisers
Know how they are compensated so you can identify where they may have conflicts of interests or biases toward certain products, services and/or fund companies. Are they compensated by collecting commissions on products they sell or do they just charge fees? Know their background and track record. You can go to finra.org or cfp.net to run a background check and determine if your adviser has any complaints or disclosures on his/her record.
Know what you are worth (net worth = all your assets minus all your debts) and track that on a quarterly basis
Over time, your net worth should increase as you save and invest and pay down debts. If you see a steady decline in your net worth, and if it’s hovering dangerously close to zero or worse, if it’s negative, then it’s time to pay down the debt.
Know what you are making, what you are spending and what you owe
Make sure that your debt payments are less than 36% of your income and do what you can to eliminate all high-interest rate debt.
Know your financial goals, your time frame for reaching each goal, your risk tolerance and the asset allocation that is appropriate based on your time frame and risk tolerance
Stick religiously to this asset allocation and do not let an adviser talk you into changing it due to unusual “once in a lifetime investment opportunities.” In fact, if your adviser ever utters the words “once in a lifetime investment opportunities,” that’s a red flag and you’ll want to start looking around for another adviser who has a more measured and realistic approach.
If your adviser takes it a step further and promises investments with a guaranteed high return, then it’s time to change advisers immediately. No investment opportunity is worth making dramatic changes to your asset allocation. This is an indication that you are taking on additional risk.
Know the tax consequences of your investment decisions
For example, a mutual fund held for more than a year is granted capital gains tax treatment, which is generally lower, while many common investments such as tax-deferred annuities are taxed at the higher ordinary income tax rates when sold. Understanding your tax consequences and managing your taxes can make a big difference in your overall returns.
Know your insurance policies and calculate the most you will pay in the event of a disaster
Read the fine print. For example, on health insurance, many people focus only on the deductible and forget about co-pays where they pay around 20% of their medical bills up to a certain amount. For each insurance policy, you should know how much you would have to pay out-of-pocket in a worst-case scenario, and you should be comfortable with that amount. If you are not, consider saving more in your emergency fund or purchasing more insurance.
Finally, know what you don’t know
Make a list of the financial topics you do not know much about and determine how important they are to your financial future. For those things that are important, make a commitment to learn the basics.
I’ll never be a mechanic, but I now know the difference between a carburetor and transmission–and more importantly, I’ve learned to identify basic car problems so I can spot (and in some cases fix) them before they occur. After a scary incident on the freeway, I realized that what I don’t know could kill me. The stakes aren’t quite so high with finances, but the consequences are still dire. What we don’t know could bankrupt us and jeopardize the future we’ve worked so hard to build–a very high price to pay for not taking the time to educate yourself.
The views of the author of this article do not necessarily represent the views of Gradifi. We make no claims, promises or guarantees about the accuracy, completeness, or adequacy of the information contained here. Readers should consult their own attorneys or other tax or financial advisors to understand the tax, financial and legal consequences of any strategies mentioned in this article.