Money mistakes can sneak up on you. You may not realize how much of an effect these mistakes can have on your finances until you’ve already lost a pile of money.
If you learn to spot those financial faux pas and correct them early on, you can save yourself thousands of dollars — and a few sleepless nights.
1. Buying a house you can’t afford
Everyone knows what a great financial asset a home can be. However, buying a house is not like buying some shares of stock. It’s a huge investment of money, time, and energy. And if you overextend yourself financially to buy that house, it may end up being a pretty lousy investment.
If buying a house plunges you deep into debt and forces you to turn to credit cards to catch up, you’ll end up spending more on fees and interest than you can possibly make back from your “investment.”
Mortgage lenders typically recommend you limit yourself to a monthly mortgage payment that’s no more than 28% of your pre-tax income. If you can’t find a house for less than than, you’re better off renting until your situation changes.
2. Not saving at least 10% of your income (and more is better)
Setting aside a reasonable chunk of your income on a regular basis can reap huge rewards for you. First, buying investments that have decades to grow will get you an enormous return thanks to compound interest. Second, having a savings account with a few months’ worth of expenses can spare you from having to rely on credit cards during emergencies, which means you’ll save a fortune on interest and other debt-related charges. And third, having money saved up gives you more flexibility in your lifestyle choices. For example, if you want to pursue a career in a field that has great earning potential in the future but pays very little today, having some cushion in the bank will make it a lot safer and easier to go for the dream job.
3. Ignoring your investments
A buy-and-hold investing strategy has a lot of advantages, not the least of which is that it requires far less time and effort on your part to maintain. However, that doesn’t mean you can set up an automatic investing plan and then ignore it for the next 30 years.
At a minimum, review your investments once a year and decide whether or not you’re happy with their performance. This annual checkup will allow you to rebalance your portfolio and replace investments that no longer suit your needs, whether they’re underperforming or they don’t fit within your changing strategy.
For example, if you’re near retirement and still have 70% of your portfolio allocated to stocks, then a sudden market downturn could wipe out a big chunk of your savings right before you need them to live on.
4. Timing the market
Yes, it’s possible to make a fortune if you time your investments perfectly by buying stocks at market lows and selling it at the highs. However, it’s also possible to make a fortune by winning the lottery — and I still wouldn’t recommend lottery tickets as a sound investment.
Timing the market turns investing into gambling, pure and simple. Because no one can predict with certainty whether stocks will rise or fall, even professional investment managers get it wrong more often than they get it right.
To make matters worse, you’ll have to pay commissions and possibly taxes each time you make a transaction — and market timing typically requires lots of transactions. These expenses can severely erode your returns, even if you manage to time all your trades perfectly (which you won’t).
So unless you have a crystal ball that will tell you exactly what the market is about to do, stick with buying quality investments and hanging on to them for long periods of time.
5. Keeping all your money in savings
If you just stick all your money in your savings account, your bank will love you — but inflation will eat away at that money over time until you have nothing left. Because inflation averages about 3% over the long term, you need to make at least a 3% return on your money just to break even.
And it’s safe to say that there is no savings account in existence that pays 3% interest. Keep just enough money in checking to cover your expenses and protect you from overdrafts, and only sweep enough into a savings account to cover emergencies (perhaps with an online-only bank, which will pay far more in interest). Then direct the rest toward retirement and/or brokerage account investments.
As a quick example, if you left $ 10,000 in a savings account paying 1% interest for 20 years, you’d end up with $ 12,202. If you left that same $ 10,000 in a tax-deferred retirement account that earned an average of 7% annually for 20 years, you’d have $ 38,697.
6. Not having goals
Where do you want to be in 10 years, financially speaking? How about 20 years? If you don’t have a goal, you’ll have a hard time coming up with a savings plan — and that means your money will be flying out the door for expenses instead of quietly making you thousands of dollars in maturing investments.
But if you set reasonable financial goals, and have a plan to meet them, you can accomplish amazing things. Maybe you’d like to have enough saved up for a down payment on a house within five years, and you’d like to be a millionaire within 30.
Sit down with a financial calculator, come up with a saving plan that will get you there, and in 30 years you can be sitting on the porch of your paid-off house looking at a seven-figure bank statement. Now that’s a financial future worth looking forward to.