There are strategies we need to put in place that will help lead us where we want to be in life, but just as important is avoiding financial mistakes.
When making our plans, we can project working in a certain career, earning a certain income, investing and having X amount of money by age Y, living in a certain size home, and even planning out a career for our children. But few of us ever give serious practical consideration to the things we don?t want to do!
Two or three major mistakes can derail the most well intended plans so it?s best to play devils advocate from time to time and seriously consider the question ?what can go wrong here?? It should be done with the same level of intensity that we give to the plans that we hope will move us forward.
Below is a list of ten financial mistakes I?ve culled over the years from my experience in public accounting, from working in the mortgage business and from a few dives into an empty pool I?ve taken on my own road of life.
1 ) Investing in things you know nothing about
When it comes to investing, we often make the assumption that if it?s working for others, it?ll work for me.
But even common investment vehicles, like stocks, bonds and real estate can be more complicated than they seem at face value. For example, people often pay market price for real estate they plan to hold for investment; the few people I know who are successful real estate investors never pay full price. No discount, no deal! Some people think they?re investing in the stock market, when in reality they?re speculating. Know what you?re getting into before you invest; once you?re in, it?s already too late. ?Buy and hope? is NOT an investment strategy!
2 ) Putting most of your money in the stock market
Most people it seems are herd investors; but herds lead to manias and manias lead to crashes. Herd investors tend to be ?fully invested? at market tops and reluctant to commit funds at the bottom. In my accounting and mortgage careers, where I?ve had a chance to look at the investment habits of probably thousands of people, I?d say the majority have 80 to 100% of their money in the stock market near market tops.
If you?re really committed to long term investing, balance is a big key since no investment is ever guaranteed. It?ll take several years of above average investment returns to overcome a single 50% hit to your portfolio. Here?s where that question–what can go wrong here?–is especially relevant!
3) Debt consolidation
Any attempt to eliminate debt without actually paying it down is a shell game we play with ourselves to make debt more tolerable. While I?m sure there are debt consolidation success stories out there, anyone in the mortgage business can tell you that most people who did consolidation mortgages or equity lines came back a year or two later with more debt to consolidate.
4 ) Buying a new car every 5 years (or less)
By being routine new car buyers, we lock ourselves into paying the new car premium anytime we make a purchase. But by buying a car that?s two to five years old we pay closer to true book value and the new car premium is virtually non-existent. Or by buying a new car and keeping it for ten years, we cut the number of new car premiums in half as well as increase the amount of time we drive a car with no payment on it. Will that help your bank balance?
5 ) Not using coupons or taking advantage of discounts
Advertising, attractive stores, credit cards and a heavy cultural bias in favor of convenience have reduced many of us to impulse buyers. We want what we want with the fewest hassles and we want it now. By shopping that way, we?re always paying full price for everything. But by adding some research, coupon clipping and a healthy dose of patience, and we can often buy what we need at 10 to 50% less than the shelf price.
It may not be a huge windfall on any single purchase, but practiced over time, it can add up to thousands of dollars in savings. Any time you’re going to make an important purchase, go to the merchant’s website (or their competitors) and see what kind of specials they’re running, or any coupon offers they have. Think auto repairs, restaurant meals, hotel rooms – just about every vendor runs specials.
6 ) Turning all of your money over to a single investment manager
It would really be easier to turn our money over to a single money manager or mutual fund, and let them take care of our investments while we go off and do what we do best. However few people can beat the market consistently, even if we?re paying them a fee for doing so. No one cares more about your money than you do, so it pays to diversify among investment managers in much the same way as you would if you were building a portfolio. It?s your best protection against a manager who loses his touch, makes desperate investments or worse.
7 ) Trading up on your house every few years
Each time you trade up three things happen: 1) you pay thousands of dollars in closing costs, 2) your mortgage resets to Year 1, and 3) the overall cost of your lifestyle expands. This is often the single biggest reason people feel as though they aren?t any better off financially, even though they?re making more money.
8 ) Not having a savings cushion
People often forego pure savings because of the low rates of return, but having a savings account may be the most underrated financial move of our time. Having ready savings available is probably the single best way to avoid using credit cards for emergencies. In addition, idle cash has a way of eliminating stress; we worry less about unexpected expenses and sleep better at night?both of which enable us to be more productive in our careers. Can we put a price on that?
9 ) Living in perpetual debt
One of the major downsides to the low interest rates of the past 20 years is that it?s lowered our inhibitions to debt. When we come to view debt in almost benign terms, we?ve entered dangerous territory. People go into debt, consolidate (see #3 above), then take on more debt. If we?re debt free, we?re free to go where we want, do what we want, make moves and take career chances that aren?t possible when we?re up to our necks in debt. Debt is something to be avoided, or paid off?then avoided.
10 ) Taking on student loan debt that?s out of proportion to expected earnings in your new career
We often think that if a little bit of something is good, more of it is even better. Student loans are an area where that thinking is prevalent. A college education may be a positive attainment, but like everything else in life, it does have limits. Taking on $80,000 in student loans to enter a career field with a starting salary of $40,000 can put you behind the eight ball, and make you debt dependent early in life. Student loans must be paid back, so make sure that the amount of debt you incur is commensurate with the typical compensation in the career field you plan on entering.
Have you made mistakes on any of these? Or are there any other financial moves you can think of that should be added to the list?
This started to scare me. 1-3, guilty, guilty, guilty.
I got into real estate right out of college not really having a clue. Over the time I had those properties I lost enough cash each month that I had I invested it in the market I’d be retired by now. 85-00 the market was on a tear.
Our non-stock position is too low, and over the next years will migrate it to the 60/40 that would be the mix I want at retirement.
In the real estate mess, I charged day to day expenses as I had tenants not paying. At one point, I owed $30k on CC. The payment was $1500/mo at that point. I managed a ‘liar loan’ equity line and reduced the payment to $300. Fortunately, that’s all behind me, I kept the one good property (of four I bought) and the total cost mort/maintenance/tax is $1200 vs the $1400 rent. I can handle any repair cost without issue.
It ends there, the next 7 I avoided.
Joe – Your experience reads more like a learning curve issue, and hopefully you made a bunch of money along the way.
The pseudo real estate investors I was thinking of in the post are more along the lines of the casual type who think that they’re going to buy a neat, clean, single family home in the suburbs, rent it out, and in five years they’ll be rich without having to do anything.
It’s very much a business, and it sounds like you approached it that way.
My husband and I had serious debt lifestyle problems when we first married, but overcame those (but not through debt consolidation). And my first investment move was to get a managed mutual fund for an IRA via my insurance agent, in something I didn’t really know about at the time. Happily, we didn’t have much money, so most of our investing goes into low cost investments that I research. Other than that, really the only issue I have is that I’m not hugely fond of clipping coupons, and sometimes I don’t honestly think it’s worth hours of my time to scour various sources for coupons. 🙂
Miranda – Insurance agents really push their own company’s investment funds, but they seem to carry fees that are well above average. At least you got hit on a small base amount, then moved on to better options. No small number of people have sunk a big chunk of their funds into those, and they often hold on precisely because they paid so much to get in.
I agree with all of these. We were guilty of 1, 2 & 8 earlier in our marriage, but have managed to turn them around. In terms of investing knowledge, I’ve actually reduced our equity exposure over the past few years as I’ve learned more about the markets. We have owned zero equities for the past few years, but may consider re-entering once the financial system looks a little healthier.
I’m with Miranda on the coupon thing. If I happen to see a great offer, I’ll take advantage of it. But I’m not willing to spend hours scouring the papers for them. I do, however, try to buy things on sale whenever possible – especially staples like cereal, juice, laundry detergent, etc. If we are planning a major purchase, we always do our homework and wait for a sale.
Balance Junkie – That was perfect, “I?ve actually reduced our equity exposure over the past few years as I?ve learned more about the markets.”
You reduced exposure as you learned how the markets work–that message is lost on so many people and that’s why so many ride the markets down in crashes. The more you learn, the more conservative you become.
From what I’ve seen, I think asset build up happens more quickly with people who are at least moderately conservative. Maybe that’s because they don’t lose as much on the way down. That’s a huge lesson.
These are all really good points. I know several people that consolidated their debt and then just jacked their credit cards right back up.
My biggest mistake right now is probably being overweighted in equities. Fortunately I don’t need any of that money right now, most of it is long-term money. But I know I need to reevaluate and rebalance as I have not done it in awhile.
Just a comment on coupons. I am an avid clipper, and it doesn’t take me hours. I actually kind of enjoy it. I just take my circulars in the car with me and clip while the kids are at soccer practice or whatever. I probably spend half an hour a week on it, and that includes sorting and getting the coupons for my shopping trips. Once you are organized, it is really quite easy.
Everyday Tips – my wife is the coupon clipper in our family, and she does the same thing–clipping and organizing while watching TV, listening to music or even talking on the phone.
Probably one of the most destructive financial mistakes we can make is to marry someone who doesn’t share similar core values.
That’s probably bigger than any I came up with! Shame on me…
Excellent tips. For most people, a new car is never a good idea. Most of us can’t afford a new car. We just hate to admit it. Just because you can make the payment does not mean you can afford it or that buying it was a smart idea.
So true. What’s amazing is that the average new car costs about what a typical house would have cost back in the 1970s. We seem to be immune to high prices–as long as credit can make up the difference…
Great list here Kevin!! The only thing about #6 I would raise up is the fact that if you are using multiple investment managers, you should at least have one financial planner who is quarterbacking your situation so that all your investments are working together toward a common goal.
I’ve seen all too often where multiple investment managers had too much correlation and actually if you looked at the overall portfolio is wasn’t as diversified as people thought.
That’s a great point Jason. There has to be cohesion, and a good financial planner can provide that.
It goes to prove that you have to be responsible for your financial actions, and not ever completely trust them to others.
The stock market is actually the biggest component to my investments. My hoard, so to speak. But my safe money is vested primarily in a few commodities which are virtually impossible to crash, like gold and silver (depreciation’s possible though!) One of my biggest elements in the stock market however is that I’m bearish as a whole, focused primarily on dividends. I’m guilty of riding out on crashes, but I never sell on them. I guess I focus more on dividend stats and the share quantity more than I do the value.
I never, ever pray for capital appreciation on my shares though, and I always expect a crash. I may be making mistake #2, but I’m wary not to make #1.
I think my most common mistake there is buying high. But I buy high, mid, and low, focused primarily on cash flow rather than share value. I know I’ve much yet to learn in the stock market as a whole, but I seek to master it sooner or later.
Aury – You’re a classic longterm investor. Your focus is on cash flow rather than stock performance. That’s patient capital and it always seems to win out in the end. Counterbalancing it with commodities sounds like a smart strategy as well. It looks as if you fit into the category known as “sophisticated money”. You have a plan that’s fundamentally sound – because it focuses on fundamentals – and you stay with that plan no matter what the trend du jour is.
You should have posted this on Where Do YOU Think the Stock Market is Headed?–it would be very relevant there too.
#2, #4, #7….. killers!
Hey Kevin – excellent post!
It’s funny how #1 and #7 go hand-in-hand. A lot of us were confused on how a house fits into our “investments”. A few years ago it looked like home values would only keep going up. Herd, mania, crash!
Probably the most disappointing mistake is living in perpetual debt. How we ever got used to sending someone else our money (so they could get rich) is beyond me.
Thanks for all you’re doing!
Good points Derek! I think the problem with the herd mentality, both in regard to the housing bubble and all of the debt, is that it works while it works! As it does it eventually sucks in even the skeptics who see the potential disaster in the distance. The “better to be wrong with the herd than to be right standing alone” idea comes into play.
I remember people saying confidently at the height of the housing boom, “if real estate crashes, the government will bail us all out”.
I think the transaction costs associated with buying/selling cars and houses is a key point — each time you buy a car, you need to pay taxes and then you immediately start incurring depreciation; each time you buy a house you pay enormous fees. If most people just minimized these two things, they’d save tens of thousands of dollars over the span of their lives.
Regarding your point about investment managers — I disagree with even having an investment manager in the first place; I think people can get better results managing their own money. If they want something quick and easy, select passive funds, and allocate stocks/bonds based on age and risk tolerance. If they want something more complex, go into individual stock picks ONLY after DIY your own research. No one will care about your money more than you.
Paula – I think most people tend to ignore transaction costs, maybe we just write them off as part of the cost of doing business. But they do take a real chunk out of your wealth, especially if we’re trading up on a regular basis. Entire industries are build on our need to change–that gives you an idea how much money is being lost “trading”.
As to your point about money managers, I’m basically with you. The exception of course is that you might be better off paying an investment manager than trying your own hand if you either lack investment skills or lack the commitment to develop them.
I’d add Setting and Forgetting your retirement accounts. While too active management is not a good idea, people should monitor and maintain control over their retirement plans, rollover to and consolidate IRAs. Then it will be less likely that you’ll have inappropriate asset allocation or panic when a 1987, 2000, 2008 and the next one comes along.
Hi Bill–Yes, that’s a big one. Everyone wants to play the invest-and-forget-and-one-day-I’ll-be-rich game, but real life doesn’t work that way. Even if you pay someone else to manage your retirement money for you, you still need to engage in some form of active management. Investing is a bad place for assuming anything.
I think #7 “Trading up on a house every few years” is the best advice on the list.
Since you are always in debt and resetting your mortgage you have no hope of ever being out of debt. That’s a pretty dreary way to live.
Also, I like that fact that you called out that all of the related expense of having more house also cost money.
Thanks Alexandria! Yes, trading up on your house has a domino affect. Not only to related expenses rise (insurance, utilities, maintenance) but your consumption patterns as well. Then there are transaction costs like closing costs and moving expenses. It’s like running on a treadmill to nowhere.
I have invested in real estate without doing
my homework properly, thankfully it turned out
ok because I could afford to hold the property
until it sold at a price I was willing to
accept, but it would have been very costly
otherwise. Never again!
Hi Pauline–At least you got out a price you considered acceptable. That’s not a complete disaster. And if it’s the worst mistake you made, it wasn’t a bad one.
Here’s one you missed: How about having an expensive “wedding, rings, and honeymoon”? All that can often set a just-starting-out-together-in-life couple back easily more than $30,000 (or sometimes much more) at a time when that would make a wonderful cash cushion, or down payment on a home, payment for a really solid used car, or even just pay for monthly date nights for the next 10 years of marriage.
We just forewent all of that, mostly for reasons of just not desiring it, but it was a financial non-issue, too, which was a nice side benefit. For those who do want a wedding, everything can be done cheaper than it is often pitched at, and it can still be a fun, warm, and memorable event.
(whoops, make that *weekly* date nights, at $62.50/date)
Don’t even get me started on that one! It’s heartbreakding seeing a working class family spending $20-,$30-,$40-, $50-000 on a massive wedding celebration, as though the opulence of the celebration will somehow insure a good marriage. This is where custom and tradition weigh heavily–“I can’t afford it, but this is the WAY IT’S DONE.” I say, dare to be different! That kind of money – if it were given to a couple in cash instead of by a wedding bash could make a huge, positive difference in their lives.
My wife and I did ours for just a few thousand dollars. The wedding was very tasteful, all the guests (+/- 60) had a great time, and we’re still happily married 20 years later. We mostly did it by keeping the guest list to a minimum. Most people invite everyone they even slightly know so as to have a big turnout. We went over an expanded list first, but determined that we would only invite those that we a) have a close relationship with, and b) were likely to see in the future. Those two criteria cut the list by at least 2/3. And today…no regrets!
I once impulsively bought a stock I knew nothing about. Never again. (Thank goodness I didn’t buy too much of it.)
Hi Stephanie – Don’t kick yourself for that, we’ve all done it. Now you know hwy you shouldn’t do it, and you won’t make that mistake again. Pain always seems to be a better teacher than anything else! Hopefully you didn’t lose too much on it. If not, consider it to be an inexpensive lesson.
I don’t know if debt consolidation is really that bad. As long as you stay focused on paying it down usually consolidating the debt just gives you a cheaper interest payment. Do you have any sources for the comment about a lot of people going back later to consolidate more debt? I’d be interested in reading a bit more on that
Hi Stephen – I saw it all the time in the mortgage business. I agree that in theory debt consolidation can work wonders. But in practice is usually acts as a “get out of jail free card” enabling the debtor to go on to take on more debt. We can go on and on about the interest rate component of debt consolidation, but any plan that does not involve aggressive repayment of principal is doomed to fail. It’s just about rearranging your debt to make it more tolerable, and not about actually getting out of it.