What’s Probably Missing From Your Financial Plan

February 21, 2013

When people call our financial helpline or schedule a one-on-one consultation, they usually have a particular problem or goal in mind. It might be getting out of debt, knowing whether they’re on track for retirement, or dealing with a thorny tax issue. But sometimes we have people that seem to be doing all the right things. They have no high-interest debt. They have more than adequate savings for emergencies. They’re saving enough for retirement. They just want to know what they might be missing. Here are the most common holes in people’s  financial plans:

Life insurance

Too often, people just have whatever their employer provides to them, which is usually equal to their salary. The bad news is that if you need to provide income to dependents, this won’t be enough. (You can estimate your own needs with a calculator like this.) The good news is that if you’re in decent health, a term life insurance policy is relatively cheap. For example, a 40-yr old non-smoking male with average health can purchase $500k of life insurance for less than $70 a month in CA on a site like term4sale.com or truebluelifeinsurance.com. The problem isn’t that people don’t know the importance of life insurance or can’t afford it. The problem is that it’s too easy to procrastinate. But doing so could mean that deteriorating health makes it unaffordable or even worse, your family needs it before you purchase it.

Investment diversification

One of the biggest investment mistakes I see is having too much in company stock. This can come about by employees allocating too much of their 401(k) contributions into their company stock or because they have options or restricted stock grants that vested and they simply allowed them to accumulate. Either way, having more than 10-15% of your portfolio in any one stock is extremely dangerous because unlike the market as a whole, an individual stock can go to zero and never recover. It’s even more risky when it’s your employer’s stock because your job is already tied to your company.

Company stock isn’t the only way many employees aren’t adequately diversified. Many just invest in a stable value fund, maybe some bonds, and  large cap US stock funds like an S&P 500 index fund. Other asset classes like international and small cap stocks are significantly underweighted or even completely neglected altogether. This can be a bad idea because those areas may significantly outperform large cap US stocks in the future. In fact, small cap stocks have historically outperformed large cap stocks over long periods of time and emerging market stocks have been outperforming recently. Of course, there’s no guarantee that these trends will continue but that’s why it makes sense to have some eggs in all these baskets.

Umbrella liability insurance

This little-known type of insurance covers you in case of a lawsuit that exceeds the coverage provided by your regular auto and renter’s or homeowner’s policies. It can be especially important for anyone whose assets make them a target but your future income could be attacked too. It generally only costs $100-200 for that extra peace of mind.

Long term care insurance

Just as we don’t like to think about death, we don’t like to think about having to spend time in a nursing home someday. But if we live until age 65, the odds are more likely than not of needing long term care at some point in our lives. Since Medicare doesn’t really cover it, you’d have to rely on Medicaid, which requires you to spend down pretty much all of the assets you’ve built up over your entire life in order to be eligible. That means not having long term care insurance can effectively erase all the good saving and investment decisions you made. To avoid purchasing too little or too much insurance, see if your state offers a long term care partnership program. If you buy a policy through one of these programs and use up all the benefits, you can qualify for Medicaid while still keeping an amount of assets equal to the insurance coverage you purchased.

Estate planning

Estate planning documents like a will, advance health care directive, and power of attorney allow you to make financial and health decisions or empower someone else to for a time when you’re unable to either through death or incapacitation. Once again, this is another topic we’d all like to avoid and once again, this could be a big mistake. Imagine your family fighting over medical decisions for you or over who should inherit what asset or having to wait for months and pay thousands of dollars in legal fees while your estate goes through probate. Fortunately, you can get most of the basic documents done at little cost on sites like legalzoom.com and legaldocs.com. However, you may want to have an attorney at least look them over to make sure there are no costly mistakes. Depending on your state, you may also be able to avoid probate on your bank accounts with a POD (payable on death) designation and on investment accounts, vehicles, and real estate with a TOD (transfer on death) registration. Otherwise, you may want to hire an estate planning attorney to draft a trust.

While these topics may not seem as urgent as paying down debt, saving for retirement, and reducing your taxes, they can be the most important part of your financial plan when you need them. The problem is that if you don’t have them by then, it will be too late. What are you waiting for?