Money traps to avoid

Personal financial management is a subject not taught in most schools, but it is vital to financial success. It may seem like it is all about paperwork and numbers, but in reality, your finances are just as much about psychology, habits and the values you choose to live by.

Put another way, your mindset matters just as much as the math.

If you want to make financial management as painless as possible, here are five traps you need to consciously steer clear of.

1. Not saving for retirement

According to the Retirement Benefits Authority, more than nine in 10 Kenyans are not planning sufficiently for retirement, while those in pension plans contribute too little to cover them in their sunset years.

The average person who retires at 60 can look forward to another 16 to 20 years of life, so it’s never too early to begin planning how to spend these years.

When you’re in your 20s, it’s easy to put off saving for retirement because it’s a far-off goal, and just making your day-to-day budget work may already be a challenge.

Soon enough, you reach your 30s and your priorities shift to saving for a house or paying for childcare, which pushes retirement to the back-burner. The fact is, it may never be easy, but it will always be necessary.

Avoid this trap: There is no greater benefit to the growth of a retirement account than time. As soon as you start a new job, sign up for your employer’s retirement plan. If your employer does not offer one, set up an individual retirement account and automate your monthly deposits. If you start early, your earnings will have a chance to generate more earnings, growing your savings at an accelerated rate over a longer period.

2. Skimping on an emergency fund

An emergency fund’s purpose is to provide financial backup for unexpected expenses, such as home repairs, medical emergencies, temporary unemployment or any other setback life throws your way.

To create an emergency fund, you need to have at least six months’ worth of expenses saved up in a secure, liquid account so that the money is available when you need it.

Avoid this trap: Reserve six months’ worth of living expenses in a separate account. The figure may be daunting, but you don’t have to get there immediately. Channel part of your salary automatically to a separate account, and remember to increase your savings rate as your earnings and costs of living go up. You will make steady progress with time.

3. Not diversifying your investments

Some of us might have too much of one type of investment in our portfolio. What many people fail to understand is that there is a huge benefit to owning many different types of investments. Diversification of your portfolio reduces its volatility and risk.

Each investment responds differently to changes in the market or economy. If events shake up stocks, then bonds or real estate holdings might rise and help smooth out your portfolio’s overall return.

Avoid this trap: Ensure you have investments across various sectors, industries and geographical areas. Once you have a diversified portfolio in place, revisit its allocation mix on a yearly basis. Alternatively, consider having an investment advisor who takes care of diversification and rebalancing for you.

4. Falling into debt traps

The older we get, the more complex our financial affairs can become, and we might find ourselves in debt in one form or another. One of the secrets to creating good cash flow and building your savings is to try to avoid some common debt traps including:

The excessive home loan

Home ownership is a great dream. Unfortunately, some home buyers get carried away with the dream and do not consider the reality of servicing a large loan. To buy their dream home, they may borrow an amount that appears to be within their means to repay, but fail to take into account changing circumstances, such as interest rate increases or loss of income.

Misuse of credit cards and

personal loans

Using credit cards can be a very convenient way to pay for things like groceries and bills. It is easy and you do not need to carry cash around. However, if you do not pay off the full outstanding balance every month, the interest will start to add up. Personal loans also help you manage cash flow dilemmas in the short-term, but you may want to use them in moderation.

Avoid this trap: Debt is not necessarily a bad thing if it helps you achieve a worthwhile goal. However, if you lose control, it can be a big trap. Your debt is a problem if you cannot reasonably pay your expenses, save something for the future and still make progress toward paying off the debt.

If you have more than one loan, set up an elimination plan that will snowball your payments. Focus on paying off one debt at a time and once you’re done, move all the money you were paying for the first debt to the next one. Once you’re out of debt, make a commitment to stay out of it.

5. Spending all or more than you earn

If you spend more than you earn, you will end up in a spiral of debt. If you spend exactly as much as you earn, emergencies or major life changes will always find you unprepared.

Spending less than you earn gives you the freedom to save, to prepare for the future, and deal with the inevitable crises you come across. The bigger the gap between your income and your spending, the better.

Avoid this trap: Find a way to earn more or spend less. For instance, if you eat out a lot, you can consider cooking more of your meals at home. Consider creating and sticking to a budget. If you know exactly how much you have to spend each month and prioritise your expenses, you are far less likely to overdraw your account.

The writer is an investment analyst at Cytonn Investments.