Investing your money, whether in the stock market or a retirement account, is a good way to take advantage of compounding interest and secure your financial future. However, understanding risk levels and investment products can take time, and many new investors fall into the same trap as they navigate financial markets and make decisions about their money.
Here are some of the most common mistakes that first-time investors make—and how to avoid them.
Mistake #1: Not Selecting the Right Advisor
Financial advisors can teach you about financial markets and products and provide helpful input as you make decisions about your money. However, your parents’ or friend’s financial advisor might not be the best advisor for you.
Rather than choosing someone you know works with, do some research yourself. You’ll want to ask what type of clients these potential advisors typically work with, what they could do for you, what their investment philosophy is, and what services and products they offer.
Mistake #2: Making Trendy Investments
Likewise, don’t make investment choices based only on the recommendations of others. Be particularly wary of celebrity endorsements. Companies may be using celebrities’ fame to try to get you to invest. In some cases, celebrity-endorsed investment products are scams.
A better practice is to research the investment product. Does it fit your financial goals? In choosing this product, are you just going along with a trend or will the product truly be a good addition to your portfolio?
Mistake #3: Making Your Own Market Predictions
It makes sense to buy stocks when the market is low and sell them when it’s high. But the real art comes in figuring out the timing. Is the market at its highest point now, or should you wait one more week to sell? Is this really rock bottom for this company, or could you wait one month and get it for even better deal?
Rather than putting energy into predicting a stock’s ups and downs, financial advisors recommend taking a long-term, measured approach to investing. That means buying shares on a regular schedule rather than basing purchases on market predictions.
Mistake #4: Being Overconfident
Some first-time investors enter the market with an abundance of confidence, sure that they will get big returns on their well-timed stock purchases and sales. However, overconfidence can lead to major rookie mistakes, according to financial planners.
Most importantly, don’t misinterpret the market’s movements as confirmation that you made good decisions about the timing of your investment. Trading often to “beat the market” typically doesn’t work, even for investors who read the news and keep up with trends.
A better approach is to slow down on trading decisions and focus on creating a diverse array of investments. When you take a realistic viewpoint about your investment decisions and returns, you’ll make better decisions that will get you closer to your financial goals.
Mistake #5: Overvaluing Cost
In the stock market, the sticker price isn’t always an indicator of value. For example, a $6 stock may not be a bargain if the company is new and unproven. Likewise, a $3,000 price tag is not necessarily an indicator that the stock is valuable.
Rather than drawing assumptions about stocks based on their price, new investors are advised to research each stock’s value by looking at factors such as their past performance, growth potential, and leadership.
Mistake #6: Panic Selling
When the stock market tanks, it can be hard to resist the urge to dump your stocks in fear that the market will drop even lower in coming days. However, more than 90 percent of investors identify this emotional reaction as a top mistake that investors make. Unfortunately, panic selling typically ends in financial loss.
That’s because selling stocks at a low price locks in your losses and eliminates any chance you have to benefit from the almost certain recovery that will follow. For example, in March of 2020, S&P losses totaled 34 percent, and in the US, investors sold out of more than $325 billion in mutual fund positions, according to Strategic Insight. Those investors then couldn’t take advantage of the market’s 20 percent rebound a month later.
Financial advisers recommend laying low when the market turns downward. Stick with a long-term investment strategy instead of short-term decisions and wait for the inevitable market correction that will erase those losses.
Mistake #7: Holding on to Returns
While it may be tempting to spend your returns, or earnings, from the market, a better strategy is to invest them back in the market. This practice, which is called compounding, will help your money grow faster. With a commitment to savings and compounding, over time your investments should flourish.
Due to the pandemic, colleges across the United States are starting to rethink their approach to how to provide an education. In response, many families are wondering whether paying for a college education is worthwhile right now.
Recent statistics bear out this trend. In October, the National Student Clearinghouse Research Center reported that undergraduate enrollment is down 4%. Experts attribute the decrease to concerns about contracting COVID-19, a dislike of online learning, and issues with families not being able to afford tuition. Some students are opting to take a gap year or to postpone college.
While reconsidering your college plans may be an option for some, financial planners advise families to continue saving—at least in some form—for their children’s college education. The following is some information and advice on how to manage your 529 college savings plan as the educational system navigates COVID-19.
Community College An Option
One popular option for students who don’t want to virtually attend a pricey university is to enroll in community college, which is generally a less expensive choice. Some financial advisors recommend that parents pay the lower tuition for community college out-of-pocket rather than draw on their student’s 529 plan, a popular education savings plan that allows families to invest money that has already been taxed into several investment options. Your earnings grow tax-free, and withdrawals for qualified expenses are not taxed.
This approach offers several benefits. Parents can continue contributing to their child’s 529 account and increase its long-term growth potential. In addition, they will not be withdrawing money from their student’s college savings account and taking a loss during an economic downturn. Students can also take out separate loans for community college and use the 529 proceeds later to repay up to $10,000 of those loans (principal and interest), a one-time option now available under the recently passed SECURE Act. As an added bonus, up to $10,000 in 529 plan distributions can be put toward the educational debt of each of the beneficiary’s siblings, including stepsisters and stepbrothers.
Continue to Contribute
The market ups and downs over the last year may set off warning alarms for your 529 college savings plan. Your account balance may drop, which may make the plan seem less valuable. The statistics back this up. According to data from the College Savings Plans Network, the average account reached a high of $26,054 in 2019, but now it is down to an average of $25,657.
Even with so much uncertainty, advisors recommend that families continue contributing to their 529 college savings plans as much as they can. Recent research finds that many are doing just that—total investments in 529 plans have risen to nearly $374 billion, a record. Investors value the savings plans’ tax-free deductions when the funds are used for qualified educational expenses such as tuition and books.
“When it comes to 529 college savings, staying the course is an essential component of a successful long-term savings strategy,” stated Michael Frerichs, the chairman of the College Savings Plans Network, in a recent interview with CNBC.
Other Ways to Use the Money
COVID relief legislation that was passed earlier this year allowed families who had paid for tuition from their 529 plans—before classes were moved online due to the pandemic—to receive refunds from the colleges. As long as the money was deposited back into the 529 plan within 60 days, the withdrawal was not taxed.
While families have the option to leave the money untouched, there are other ways they could use it because the law allows for 529 funds to be used to pay for a variety of qualified educational expenses. Up to $10,000 per year can be spent on private school tuition for each younger child per year (private, public, or religious education for students in kindergarten through 12th grade), and in many states that amount can be applied to reduce the taxable income of the parent or grandparent who started the fund.
The money also can be used to pay for apprenticeship programs, vocational school, and other post-secondary institutions that participate in the U.S. Department of Education student aid program. Qualified expenses also include computer software, textbooks, and supplies.
The Long-Term Outlook
For families with younger children, now may be a good time to think about what higher education will look like in a decade. Some experts predict that post-COVID, the cost of a college education will become even more expensive. In order to compensate, you can change the asset allocation of your 529 plan portfolio, making it more aggressive or conservative based on your feelings about the market.
Parents may want to explore other savings options, as well, so that they can work around the restrictions on the 529 plan. Other good investment choices include U.S. Treasury bonds, one of the safest—and slowest—investments, or stocks, which will be more volatile but could provide a much larger payoff. Parents also could consider a Roth IRA savings account, which offers the tax savings of a 529 account without the restrictions.
While the 2020 U.S. presidential race remains front-page news, the outcome of the Nov. 3 election could significantly impact your income, tax bracket, and tax burden, as any changes in government officials could potentially alter the federal tax code in 2021. While neither presidential candidate has released a detailed tax plan, the information provided during recent campaigning has offered some clues as to how each candidate might approach tax policy. The composition of the U.S. House and Senate after the election will also determine the future of US tax policy, as bills altering the tax code must pass through Congress.
Here’s what we know about where the U.S. presidential candidates stand on issues of taxation:
Capital gains and dividends—Currently, the top tax rate on capital gains and dividends is 20% for individuals with incomes over $441,450 and for married couples filing jointly who make more than $496,600. President Donald Trump has indicated that he would reduce the capital gains tax rate from 20% to 15%, while Democratic candidate Joe Biden would remove exemptions for capital gains and dividends for incomes that exceed $1 million.
Estate tax exemption—For 2020, the estate tax exemption is approximately $11.6 million, and it’s scheduled to revert to $5.8 million in 2025. Trump supports an extension of the exemption, while Biden would keep the planned 2025 reversion.
Individual tax rates—For individual with incomes of more than $518,400 and married couples filing jointly with incomes of over $622,050, the top marginal rate is 37%. Trump would retain this rate and add a 10% rate cut for middle-class taxpayers. The current rate of 22% applies to individuals with incomes of over $40,125 and married people filing jointly who have incomes of over $80,250. Biden has indicated that his policy would restore the pre-2017 rate of 39.6% for taxable income of more than $400,000.
With this information in mind, financial planners are offering advice on how to manage your finances in order to maximize your wealth throughout the upcoming months.
Pre-Election Financial Strategies to Consider
Roth IRA—In order to reduce the tax burden on your individual retirement savings, financial planners recommend converting traditional IRA accounts to Roth IRAs. The reason? When you withdraw money from a traditional IRA, it’s taxed, and right now the income tax rates are relatively low. If a Democratic majority takes office in 2021, income tax rates could increase, and traditional IRA withdrawals would be taxed at the higher rate. While deposits into a Roth account are taxed, the balance will grow tax-free.
While switching to a Roth account will trigger a tax bill for making a withdrawal, you will likely will be financially better off in the long term with a Roth IRA. Additionally, don’t forget to claim losses this year on deductible items, such as depreciation on an eligible rental property that you own. The savings may be enough to offset any fees charged in a Roth IRA conversion.
Estate planning—One tax strategy to consider is to give to your heirs a financial gift before the end of 2020, as it’s unclear what will happen to the estate tax exemption. Currently, due to tax revisions passed in 2017, the estate tax exemption was doubled to more than $23 million per couple. While this benefit is set to expire in 2025, a change in the governing majority could move up the expiration date and reduce the exemption amount to pre-2017 levels. Financial advisors recommend taking advantage of tax-free gifts to heirs now and giving up to the annual exemption level.
Americans have enjoyed a relatively low tax rate on profits from the sale of investments that they have owned for more than a year. However, Democrats have discussed the possibility of increasing tax rates on long-term capital gains above the rates set during the 2017 tax overhaul. For high earners, this could mean as much as a two-fold increase in the top capital gains tax rate.
If the possibility of an increase in the long-term capital gains rates looks likely in 2021, a good strategy could be selling off profitable stocks now in order to take advantage of a lower tax rate.
Wait Before Making Any Major Decisions about Your Finances
Since it’s impossible to predict exactly how the election results will affect your taxes, financial advisors recommend that you wait before making any big decisions about your investment strategies. Some point to the lessons learned from 2012, when people sold more than they could afford based on speculation.
Some advisors recommend thinking through a 10-15 year investment plan and making decisions within that framework—even with the uncertainty that lies ahead. If you are compelled to rethink your investments now, consider compromising. For example, you could convert part of your traditional IRA to a Roth IRA now and then decide about whether to convert the remaining balance after the election.
“The election will happen, and we’ll know the results. But we won’t know what the tax plan will be this year,” said Bryan D. Kirk, Fiduciary Trust International director of estate and financial planning, in a New York Times article.
If your target retirement age is less than 10 years away, it may be tempting to glide into your post-work life and hope for the best. However, without proper retirement planning, you may find yourself making a bumpy landing.
Here are seven steps to ensure that you’ll be financially prepared for retirement.
Consider Your Plans
As the reality of your post-work life draws closer, it can be helpful to envision what your days will look like. Will you be traveling around the world? Downsizing your house? Taking up a pricey new hobby? Will you volunteer or work part-time? All of these decisions will play into your retirement budget.
Most importantly, ask yourself if you have the money to pay for your retirement dreams. If you don’t, there’s still time to save. First, go over your current budget and look for items that can be cut. Do you need Netflix and Hulu? Could you cut out coffee runs and eating out? Any money you save can be invested in your retirement savings.
If your dreams outsize your financial reality, it may be time to reconsider what retirement will look like. Steps such as moving into a more affordable home or working a 10-hour-a-week job could positively impact your retirement budget. A downsized retirement budget, however, doesn’t mean a downsized retirement. Spending more time with grandchildren can be more rewarding than an expensive vacation to Europe.
Get a Handle on What You Have
This step can be intimidating, especially if you haven’t been on top of retirement savings. However, you need to face the truth to best prepare for the future. You need to know how much you’ve saved and how much you’ll likely receive in Social Security and pension payments so that you can calculate a reasonable retirement budget. If your retirement savings are in several different accounts, consolidating them could provide a better idea of how much savings you have.
A financial planner can help sort through your financial situation and build a strategy for retirement savings to maximize the time you have left to save. With an accurate assessment of what you’ve saved, you also can make decisions on whether you need to work more to increase income or cut back on spending to boost your savings.
Pack Your Retirement Savings Accounts
This is the time to increase your contributions to your retirement account to the maximum allowable, including making catch-up contributions permitted under IRS rules (the agency gives contributors age 50 and older extra time each year to contribute). Also, check with your employer about whether the company matches employees’ retirement account contributions.
Get a Plan
It’s easy to put off retirement savings and justifying spending what could be potential contributions to other items. However, it’s never too late to map out a retirement plan—even if retirement is just a few years away. A financial professional can help you maximize your savings, create a strategy, and chose the most advantageous options for claiming your employee pension or Social Security when the time comes.
Pay Down Debt
Retirement budgeting will be much easier with less debt, and it’s wise to pay off as many loans and outstanding balances as possible while you’re employed. That can mean making extra mortgage payments, paying off credit cards quickly, and limiting new debt. One wise move is to pay cash for larger purchases to avoid additional credit card spending. The overall benefit? Less of your retirement income will go toward debt interest payments.
Choose your location
Your retirement budget will largely depend on where you choose to live. Downsizing to a smaller house in a more affordable area could drop your mortgage payment. On the flip side, you’ll also need to consider your budget if you move to a more expensive house or location to be near grandchildren, which can increase your retirement budget.
Factor in Medical Costs
While it’s impossible to predict the state of our personal health at retirement age, it’s wise to consider how to cover potential increased medical costs without decimating your retirement savings. One option is to maximize your contributions to your health savings account now—if you don’t spend the money, it will grow tax free and be available to spend in your retirement.
Another option is to buy long-term care insurance, which will pay for home health aides and, if needed, assisted living facilities, which aren’t covered by Medicare. The earlier you buy the insurance, the lower the premiums will be. If you wait to buy, you’ll risk rejection from insurers if you are in poor health.
Finally, you can protect your retirement savings by investing in additional health insurance. When you turn 65, Medicare will pay for most of your routine health bills, but you’ll need supplemental coverage to fund non-routine medical issues.
If you want to leave your estate to beloved family members or friends upon your death, a life insurance payout can be key to helping them pay for expenses that could decrease the impact of your estate.
Dispersing an estate can take time—sometimes months or longer, particularly for complicated estates. In the meantime, beneficiaries can be left with bills for everything from funeral costs to debt payments.
To leave those you love in the best financial position possible, it’s important to include a life insurance policy in your estate planning. Here are ways that life insurance policies can be utilized when planning your estate.
Paying funeral fees
Even the most basic of funerals can cost thousands of dollars. Low-end caskets generally start at about $2,000, on top of fees for embalming, funeral home staff services, and a grave marker. Meanwhile, cremation costs can start at $4,000. A life insurance policy can provide immediate cash to pay these costs so that your beneficiary doesn’t have to spend their savings or go into debt themselves to pay for these expenses.
Paying estate taxes
A life insurance policy can be an excellent planning tool for protecting the wealth you plan to pass on. If you anticipate your estate will be subject to federal estate taxes, which heirs must pay within nine months, your life insurance policy can pay them instead. If your estate is primarily real estate, this strategy will prevent heirs from having to sell property or liquidate assets to pay estate taxes.
It’s not uncommon for decedents to leave unpaid debt and monthly payments, including credit card bills and utility bills. A recent study by credit company Experian found that 73 percent of Americans who die leave debt behind.
While creditors likely won’t try to get payments out of surviving family members, they often will from the estate. The collections process can send an estate into probate, which can stretch out for years as creditors try to collect from it. Life insurance policies, however, aren’t subject to probate laws. That means beneficiaries can receive the entirety of the policy quickly.
Building financial wealth
A life insurance policy, especially one with a large payout, can change your beneficiaries’ lives and your or their family’s legacy. For example, life insurance payouts can be used to pay off a beneficiary’s mortgage or student debts. Without this costly debt, they can invest or save their money, building wealth for future generations.
Replacing family income
If you are the primary earner in your family, life insurance can replace vital income if your spouse does not work or is underemployed. A life insurance payout will provide survivors will financial stability while they reconfigure their lives in your absence. Financial experts recommend that a life insurance policy cover between seven and 10 years of your income.
Life insurance also can become very important for families with young children or children with special needs. In these cases, surviving parents or guardians may not be in a position to cover the children’s financial needs on their own. Life insurance benefits, however, can pay for everything from medical bills to education.
Protecting family real estate
Family-owned property can become an immediate financial issue for heirs, who must make decisions about who will own the property. In some situations, heirs may decide to sell the property and divide the proceeds, but preparing the property for the market and waiting for a sale can take time. In the meantime, the mortgage must be paid.
In these cases, a payout from a life insurance policy can help. Beneficiaries can use it to make mortgage payments or, if they decided to keep the property in the family, pay off the mortgage.
Giving to charity
Life insurance can be an excellent way to make a significant gift to a charity of your choosing. Any charity can be designated as the beneficiary of a life insurance policy.
As you integrate life insurance into your estate planning strategy, there are many factors to consider when deciding how much and what type to invest in. You’ll need to look at whether you are the primary income earner in your household and how many people depend on you financially. You’ll also need to factor in your debts and other financial obligations (including your mortgage), whether your estate will be subjected to federal estate taxes, and whether you’d like to leave any of your estate to charity. Life insurance will provide liquidity and readily available funds for your beneficiaries.
Estate planning professionals can help you determine how life insurance can benefit your estate, regardless of your age or income. It can be a key tool in providing peace of mind that your family will be financially protected and your estate preserved as you pass it on to your heirs.