The millionaires next door have a great life. They’ve been diligent savers and investors, building a multimillion-dollar investment portfolio with a healthy mix of tax-deferred retirement accounts and non-retirement accounts.
Their balance sheet is clean, with minimal, purposeful debt financed at reasonable interest rates.
They have long-term relationships with the professionals hired for investment, tax and estate planning advice.
They’re very happy and comfortable with the knowledge that they’re on track to meet all of their financial goals, but…
Have they grown complacent?
Here are five financial planning areas where the millionaires next door consistently make strategic mistakes (and how you can avoid them, too)…
1. No Coordinated Planning Among Professional Advisors
Without a professional advisor taking charge of their big picture, a comprehensive financial plan covering investment, tax, insurance, retirement and estate planning is unlikely to exist.
Lack of coordination between advisors is a sign that they may have outgrown one or more of their long-term advisory relationships.
For example, the client’s CPA’s sole function is income tax preparation, and they aren’t involved in the financial planning process. The result is an incomplete tax strategy that could lead to missed opportunities to reduce their income taxes.
When the client’s investment managers are not involved in the financial planning process, unnecessary income taxes may be paid because they aren’t aware of the tax strategy.
Some missed opportunities to reduce income taxes include:
- Not using capital losses to offset capital gains
- No strategy for unrealized long-term capital gains and losses
- Improperly designed ownership structure for capital-appreciating and fixed-income assets
- Ignoring tax-advantaged asset classes
In addition, a lack of coordination between an estate planning attorney, the CPA and the financial advisor could undermine the estate planning strategy.
We’ve seen estate plans unravel because gifting strategies, account titling, life insurance issuance and beneficiary designations are not properly executed.
2. Inadequate Investment Portfolio Risk Management
If they’re managing their own investments, or their financial advisor’s not paying attention, the millionaires next door may be taking on more risk than they realize.
Here are some common risks they run into (that you might run into, too):
- Large allocation to highly correlated investment holdings
- Concentrated stock positions, especially their employer’s company stock
- Ignoring alternative, non-correlated asset classes
- Not using stock option strategies to hedge risk and/or generate income
- Taking unknown risks by reaching for yield
- Replacing fixed-income securities with dividend-paying equities
- Underweighted (too few) equity securities due to fear of market volatility
3. Ignoring Tax Integration Opportunities
The millionaires next door already pay high federal and state income taxes. Without planning and coordination between their professional advisors, they could be missing out on tax-integrating strategies and making these mistakes:
- Underutilizing tax loss carry-forward opportunities.
- Failing to make maximum pre-tax contributions to their retirement accounts.
- Not using tax-efficient gifting techniques.
- Not forming a business to write off expenses against.
4. Inferior, Outdated Wealth Transfer, Gifting Strategy and Estate Plan
The goal of an estate plan is to ensure the decedent’s estate is distributed according to their wishes, simplify the estate disposition process, minimize estate taxes and protect heirs.
A properly executed estate planning strategy may include trust structures, gifting techniques, strategically issued life insurance and coordinated beneficiary designations.
Failing to update estate planning documents is the most common financial strategy mistake made by the millionaires next door.
It’s an easy issue to procrastinate on. People don’t like to think about their death, and it feels a long way off. This isn’t an issue until someone passes away.
The consequences are potentially significant as assets are not directed as the decedent desired, unnecessary taxes are paid by the estate and the heirs, gifting opportunities are lost and confusion and hostility potentially arise among their heirs.
5. Financial Decisions Are Adversely Impacted by Emotional and Cognitive Biases
The millionaires next door have set themselves apart by living right and properly executing their financial strategies.
However, when markets are volatile and economic times are tough, they’re still subject to the same cognitive and emotional biases affecting decision making as everyone else.
Here are some examples:
- Loss Aversion: People feel the pain of loss twice as intensely as they feel the joy of gains. This leads to overly conservative investment strategies and portfolio underperformance.
- Disposition Effect: We hate making mistakes and recognizing our poor decisions. We make matters worse by attempting to cover up our mistakes with more poor decisions. As a result, our investment portfolios underperform because we fail to cut our losses by selling losing positions. The corollary is that we also tend to sell our winning investments too soon.
- Confirmation Bias: This occurs when we put more weight on the opinions of people we agree with and fail to consider information that doesn’t support our point of view and decisions. Falling prey to this bias could create costly blind spots.
- Bandwagon Effect: When we copy the behavior of the masses instead of making independent choices, we’re guilty of abandoning rationality and letting our emotions prevail. This ‘jumping on the bandwagon’ can be particularly dangerous at market extremes, leading to poor investment decisions:
- Buying High: When equities are exploding higher, as they tend to do at market peaks, our emotions take over, we experience the fear of missing out (FOMO), and we buy. When the market begins to decline and then extends its losses, we’re faced with regret and a litany of other negative emotions.
- Selling Low: At market bottoms, there’s mass fear, and investors are running for the exits. Investors’ fear is magnified by the media because fear sells, and they’re in the business of keeping your attention. Sophisticated investors know these occurrences are tremendous buying opportunities.
Sandene Strategies’ Solutions
We have decades of experience developing strategies to help the millionaires next door avoid common financial, non-financial and emotional mistakes. We can do the same for you.
We’re also non-judgmental about people’s past actions. If they’ve made mistakes, we make sure their situation gets fixed. Our objective is simply to get you on the right track and make a positive contribution by guiding you through our financial and life planning process.
We’ll assemble and quarterback a team of (existing and new) experienced professionals, listen attentively as you articulate your desires and create Your 360º FutureTMBlueprint.
This comprehensive financial plan incorporates the plans you have for your life and empowers your future of growth, purpose and fulfillment.
Your Blueprint can be used as a decision-making filter, creating guidelines for your personal financial decisions and actions.
Your Future Is Now. Let’s Get To Work!