I love to read books, listen to podcasts, and watch videos on personal finance, but some of you may prefer to hire someone to take care of that for you instead. And that’s okay. Whether you decide to manage things yourself or get a financial advisor, it is vital that you understand the basics. Don’t blindly follow someone else’s investment plan without fully understanding it and don’t naively trust a financial advisor to have your best interest at heart. No one is going to care more about your money than you. Before this year ends, make sure you fully understand what is happening with your money. This is why:
1. To ensure you are not being taken advantage of. Many doctors and young professionals who are unaware of how their money is invested and know very little about personal finance get taken advantage of by people they thought had their best interest at heart. They may overpay for things, have their money invested the wrong way, or be overcharged for assistance in managing their assets. When people know you have more money, they tend to raise their prices and fees because they assume “you can afford it.” Having some knowledge of personal finance will allow you to better discern if you are getting charged a fair price for good advice, or not.
2. To ensure you aren’t being charged high fees that decrease your investment returns. In order to have your money grow over time, it needs to be invested. When you invest money, you usually do so by purchasing assets that will increase in value over time. The cost of acquiring those assets can vary but the key is to make sure the fees you are being charged to have those assets are not too high. This is especially true when it comes to real estate and the stock market. Overpaying for a home or investment property can cause you to lose money quicker than you think. Investing in mutual funds (groups of stocks or bonds) with high expense ratios can cut into your profits and minimize the growth of your money. For example, if the average mutual fund has a yearly increase of 8% per year but inflation is 4%, the fund fee is 1% and your advisor fee is 1% then the growth of your money is really only 8% minus 6% which is 2% per year. We cannot control inflation but minimizing the fees we are charged on our investments is within our control. Be aware of what you are being charged for certain investments and make sure it isn’t too high.
3. To ensure you are not invested in things that underperform the market. Another disadvantage of not understanding personal finance is having the wrong investments. Although personal finance is personal, double check that you are actually making good investments, which I define as things that have a high chance of increasing in value over time. There are lots of “good” investments but there are also investments that underperform the market or change in value too frequently to be useful. Learning about personal finance helps ensure that you are investing in things that will increase at an appropriate rate over time.
4. To ensure your investments aren’t just things that provide bonuses and commissions to your advisor. Believe it or not, there are some advisors who will use your money to enrich themselves. They will come to you claiming to help, all the while investing your money in questionable ways and buying products that result in a large commission to themselves at your expense. Although some are sneaky, others have simply been trained or groomed to believe that the things they sell are good. They attended a seminar or class that taught them all the potential benefits of certain products without mentioning the drawbacks of the investments they offer. As a result, they come to you with good intentions but bad information. They may try to talk to you about the benefits of whole life insurance and conveniently fail to mention the large commission they get for selling you the policy. They may suggest that you purchase an annuity but fail to mention the high fees and lifelong commitment to suboptimal mutual funds it requires. Having some knowledge of personal finance will help you avoid this and ensure that your advisor isn’t charging you money to enrich him or herself.
5. To ensure your investments align with your risk tolerance and investment goals. Another perk of knowing about personal finance and investing is being able to ensure that you are investing in ways that give you a good chance to make a profit (with little fees) with minimal risk. You want to make sure you aren't invested too heavily in one thing. It's also important that you plan for the unexpected. If you switch to a low paying job, your child care expenses increase, or the stock market or real estate industry crashes again, do you have room in your financial plan to handle it? You need to take some risk in order to make a profit but be careful not to take too much risk. You don’t want to lose all you have over one unexpected event. Diversify your investments, buy assets in different industries and consider using the combination of stocks bonds and real estate to protect yourself against the unexpected.
6. To ensure that you know your true net worth. As you continue investing and building wealth you should be keenly aware of not only what you are investing in but also where you are in your journey to financial independence. This means you should be able to calculate your net worth. If you stopped working today, how much money would you have? What is the total amount of your assets (the things you own) minus your liabilities (the debt you owe)? If you didn’t make any more money, how long could you still afford your current lifestyle? Are you reliant on your next paycheck or do you have enough money saved and invested to continue to live life and function as you do now? Part of being money savvy is not living paycheck to paycheck. It’s not being dependent on your job. It's being aware of where you are in your wealth creating journey. What is your net worth?