One of the lessons that everyone should learn is the concept of building up net equity. Some people refer to this as a net worth statement which lists the assets you own and your liabilities (if any). The difference between these two is your net equity. One of the items that we often see missing on people’s net equity statements is the inflation factor.
For example, last year Mrs. Anderson had a net worth of $1,000,000. Inflation this last quarter was at 4.1 per cent. If Mrs. Anderson net worth (after tax) is not at $1,041,000, she has moved backwards. As we discussed in our column, inflation impacts purchasing power, your net equity has to increase annually to keep pace with inflation. The following are 10 common mistakes that people make.
10 common mistakes
1) Low rent or subsidized housing, are in my opinion, some of the most common mistakes. When individuals are paying low rent they may believe that they are getting a good deal. The same likely applies with subsidized housing. If the government is paying part of your rent, why would you ever give that up?. Unfortunately, rental costs continue to rise with inflation, and you are building zero equity. Owning your own home is equity. As house values increase, so does your home price.
2) All too often people are too private to talk about financial matters with other people. Not talking to others you trust with financial knowledge is a huge negative. Having a financial mentor to teach the importance of building up equity is perhaps the best financial gift you can receive. A mentor can recommend good books, point you in the direction of other resources to build your knowledge, refer you to a good advisor, and help you to avoid common mistakes.
3) Understanding the difference between good debt and bad debt. Over the years, I’ve had clients come in and explain to me that they are having to give money to their family members to pay off credit card debt. In some situations, the credit card charges were used for frivolous purchases that were beyond the card holder’s means. Accumulating bad debt is the exact opposite of building equity.
4) Risk is not a bad word. If I were to look at all the self-made investors who have built up equity – nearly all have taken risk. People who say that they do not want to take any risk with investing are limiting their options to cash and guaranteed investment certificates (GICs). Cash in the bank may be earning 0.25 per cent, and GICs under two per cent. Every year that money is kept in cash or GIC’s, earning less than the rate of inflation, results in net equity declining.
5) Taking excessive risk is also not advisable. Chasing the latest investment hype has consistently resulted in a negative experience. Investors who have heard about a speculative stock, or a particular theme in the media are often very late in the cycle. Hearing about a particular investment at the tail end of the hype can also result in significant losses. The saying, what goes up quickly, can also fall quickly, is painfully true.
6) Excessive concentration is poor risk management. Getting too attached to one name, or only a handful of companies, can often result in net equity being negatively impacted. We recommend a minimum of 30 individual companies to diversify risk. Don’t fall in love with one company. If sufficient capital does not exist to purchase 30 individual companies then picking up a low-cost exchange traded fund or well managed mutual fund is a better option.
7) Getting too emotional during market cycles is also a killer for building net equity. Selling after the markets have a correction is the opposite to what should be done. If the markets have a significant decline, that is the time to pick up quality holdings – not to sell.
8) Not taking advantage of tax-preferred accounts. Tax Free Savings Accounts (TFSA) and Registered Retirement Savings Plans (RRSP) are fantastic accounts for many younger investors. Other types of registered accounts are also available, and depending on your situation, can be utilized.
9) Not saving is also a common mistake. It takes discipline to set money aside every month. The long-term benefits are huge. Contributing early, and consistently will help get capital built up. We often talk about an investor who has $100,000. If that investor earns 10 per cent, then the account will increase by $10,000. If an investor has $1,000,000 and earns 10 per cent, then the account will increase by $100,000. The quicker you begin investing and building up equity, the greater number of years for compounding. I often call this the snowball effect. Many people start far too late and don’t get the full snowball effect. If you don’t have equity today, savings to get the capital built up is more important than the investment returns for building up net equity.
10) Obtaining professional advice can set you off in the right direction. I’ve seen ads on television that make fun of using the same advisor that your parents use. Although the ad is creative, it sends the wrong message. Not taking advantage of householding with family members, and mentorship, often results in uninformed choices. By householding with family members, the cost of investing can also be reduced. Paying less fees means more funds to invest and grow, further enhancing the snowball effect. [See article about householding] https://www.timescolonist.com/business/kevin-greenard-how-a-portfolio-manager-helps-families-1.24324145
Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC. Call 250.389.2138, email firstname.lastname@example.org or visit greenardgroup.com/secondopinion.