Financial blind spots you should try to avoid this year

As a financial advisor I have had the privilege of meeting dozens of new and prospective clients over the years. In working with them and analysing their affairs I have noticed several recurring blind spots in their finances. I am listing a few here in the hopes that you will be able to identify your own blind spots so that you can improve your financial life this year.

Asset allocation time horizon mismatch

Investors’ portfolios are often not matched to their investment time horizon and their goal. They are often too conservatively invested for a long-term goal and too aggressively invested for a short-term goal.

The longer your investment time horizon, the higher your exposure to growth assets (equity and listed property) should be. Conversely, the shorter your horizon, the lower your exposure to growth assets should be.

Any new investment that you need to access in a year or less should be in interest-bearing cash investments. Any investment more than seven years away should be predominantly invested in growth assets.

Lack of diversification

New clients who haven’t had the benefit of advice before will often be overexposed to a particular fund manager, asset class, geography (too much local or too much foreign), currency or individual share.

This lack of diversification could mean that they are at high risk of capital loss and underperformance. The ideal portfolio differs for each investor, but it needs to be a mixture of asset classes, fund managers, shares, geographies and currencies.  Read more: Why should I diversify my investments?

The ideal mix should suit the investors’ individual needs and future goals. A person who intends to spend their future overseas is likely to have much higher offshore exposure, perhaps even up to 100 percent of the portfolio. Someone who intends to remain in South Africa could have between 25 and 75 percent of their portfolio in offshore investments depending on the size of their portfolio, their individual needs and their preferences.

No or outdated will and no estate planning

What happens after death in terms of inheritance and their deceased estate is an area of concern for most people. They want to know that their dependants will be okay in the event of their death.

However, they often do not have a valid will in place, and those who do may have not updated it for several years.

Most people have also never had any estate planning done. Estate planning ensures that there is enough money available (liquidity) in the estate to settle all debts and costs without being forced to sell assets. Good estate planning should also ensure costs and estate duty are minimised as much as possible.  

No income tax planning

How you invest now can have a big impact on your current and future tax obligations. You need to maximise your available tax deductions, such as your retirement fund contributions, while also using the most tax efficient investment vehicles and asset classes.

Maxing out your retirement annuity, your tax-free savings account and using vehicles such as endowments (30 percent tax withheld inside the endowment) if you are in a higher tax bracket (well over 30 percent) is the way to go. Read more: What do I need to know about investing in a tax-free savings account?

Having a significant portion of your portfolio in interest-bearing investments is inefficient both from a tax and a long-term growth perspective. Interest income above the annual tax-free threshold is taxable.

Insufficient emergency fund

The rule of thumb is that you should have at least three months of expenses in an interest-bearing account to use in case of emergencies. I have found the ideal level to be at least six months.

Business owners, seasonal/cyclical/contract workers and commission earners may need as much as 12 months.

This is an essential financial safety net that will come in handy when life truly happens.

Lack of flexible investments

Many people have a retirement fund in place but are not concurrently building wealth in discretionary investments such as tax-free savings accounts, endowments, unit trusts and share portfolios.

This limits their ability to access lump sums later in life, particularly in retirement. This is essential for big ticket items such as holidays, car purchases, major home repairs, medical bills not covered by your medical scheme, etc.

While you may be able to take up to one third of your retirement fund as a lump sum when you reach retirement age – if you haven’t already withdrawn it – it is often insufficient to meet all your future lump sum needs. Depending on the amount taken above the tax-free amount allowed at retirement, it may also be taxed quite heavily.

No income protection insurance

Your ability to produce an income is your most valuable asset. This is why I am always surprised how few people have income protection insurance in place when they first approach me for advice.

Income protection is particularly important if you are self-employed. You need to know that if you are sick or injured and unable to work for a prolonged period, or even permanently, that your income is protected.

No gap cover

Finally, we have an incredibly valuable little product that very few people have heard of: gap cover.

This insurance bridges the gap between what doctors and other providers charge when you are admitted to hospital and what your medical scheme will pay. This can be a very large sum of money depending on the treatment you require and the rate at which your scheme reimburses providers.

I have seen co-payments of tens of thousands of rand be paid by gap cover. Not bad for a few hundred rand per month.

I hope that if you too have any of these blind spots in your finances that you will work on mitigating them this year.