Don't sabotage your finances with these 5 mistakes
We're all human, we all mistakes. Some mistakes are forgotten easily, others can last a lifetime. When it comes to personal finance it's easy to make mistakes as we aren't educated on the subject. Most people didn't learn personal finance basics in high school or college, no one sits around at happy hour discussing IRA's (unless you're with me) and typically we focus more on earning that saving or investing.
Prior to starting this blog I constantly had thoughts of how earning more would solve everything. I've made some significant salary jumps since graduating college but realized how wrong I was....It's not how much you earn, its how much you save! Most people get raises and inflate their lifestyle to match, instead of saving (or investing) the additional amount and keeping their costs the same. It's human nature, we want to reward ourselves for our accomplishments. This is one way most people self sabotage their finances, here are five other ways and solutions to fix any potential mistakes.
1. Lack of Saving
Most people simply don't save, when the paycheck comes they spend it all without paying themselves first. This typically creates a vicious cycle where you can never "catch up" with your spending. According to this study only 62% of Americans have less than $1,000 in their savings account and 21% don't even have a savings account!
Solution: Have an emergency fund for unexpected expenses. Don't be super stressed if something happens, be prepared. No matter what your salary is try to start by saving a small amount like 5%, or $100/month to make it a habit. Keep building on this until you have three-six months of cash saved to cover your expenses.
2. Not Contributing Enough
A lot of people contribute, but usually they just choose an arbitrary number (3%, 5%, 7% etc) instead of considering how each percentage point will impact their paycheck and future retirement goals. A good place to start is 10% of your salary. If you can get to 15-20% you're above average and setting yourself up for a fun, traveling future instead of working when you're 60+ years old. If you really feel like being an overachiever strive towards contributing the maximum amount; $18,000.
Do you know how much you're currently enrolled in? Could you go up 1-5% each paycheck and still maintain your current lifestyle? Since 401K's are pre-tax money even 1% will make a big difference when annualized out over the year.
Solution: Make sure you're enrolled and contribute enough to get your full employers match. From there increase by a % point for a few months and see how it affects your budget. With any raise make sure to keep your expenses the same and invest the extra amount. Too many people get a raise or bonus and increase their cost of living, instead of living on the same amount and stashing away the rest.
3. Not Understanding Your 401K
This isn't your fault, we are not taught about picking the right funds in school or even in the real world. Plus we're easily convinced to trust "financial advisors" from their commercials we all see about how they care about your family, your money, your goals, your future etc...most of that time that is a bunch of BS.
There is an abundant amount of information out there and it's hard to decipher what to do or who to believe. For example once you enroll in a 401K you are often asked to select from the list of funds (usually 20-30) or go with a target date fund or some automated program that is suppose to "look out for your investments." While it's easier to do one of these options, it's not the smartest as you'll end up potentially losing thousands of dollars by retirement age. Typically these "auto-enrollment" programs select higher cost mutual funds. They rarely perform as good as mutual funds but also take a lot more of your money in fees (which is how they make money). So you're basically figuring out the maze within your 401K. But it doesn't have to be that hard if you understand what you're looking for.See my full post here on evaluating your 401K/403B.
Solution: Sort your 401K funds by expense ratios, find the ones that are the lowest cost and cover the entire market (index funds) instead of high cost mutual funds. This ensure you'll have more money for retirement as your profits won't be eaten away by investor fees.
Don't believe me on high cost mutual funds ? Check out Jon Oliver destroy the mutual fund industry and 401K's here!
4. Only Using a 401K
Figuring out a 401K was hard enough, why should I invest in a Roth IRA as well? What is a Roth IRA? How can I afford to save even more?...Again all good questions, check out my Roth IRA page here to get a quick overview of the benefits from investing in a Roth.
In doing some research (which wasn't easy to find) only a small percentage of people actually have a Roth IRA and I personally only know a few of my friends/family with one as well. By not setting one up you could be losing out on so much money over your lifetime. According to this 2012 study: "IRAs are a vital component of U.S. retirement savings," says EBRI, constituting 26.5% of all retirement holdings. There are nearly 15 million IRA accounts held by more than 11 million people with total assets of just over $1 trillion.
Solution: Open a Roth IRA at a brokerage account, preferably Vanguard (see here). It will take 5-10 minutes and you can start contributing money. Once you transfer money then you can start picking low cost index funds to keep growing your money tax free.
5. Carrying A Balance on Credit Cards
If you have credit card debt you are not alone. According to Nerd Wallet the average household has $15,762 of credit card debt! While there are some instances where credit card is understandable I'm sure a lot of this debt could be avoided. The fees you pay in interest can make it tough to get out of debt if you rack up to high of a bill.
You have $5,000 in credit card debt. Your minimum payment is typically between 2% and 5% of the total balance. If we assume it is 4% it would be $200. Of that $200, $62 is going to interest and only $138 is actually going toward the $5,000 in debt. Calculation below:
APR typically runs between 12% and 17%. Let's assume for the example, the APR is 15%.
Divide the APR by the days in a year: 15% / 365 = .041%
Multiply .041% by the average days in a month, 30 = 1.36 or .0136%
Then, multiply .0136% by the original balance, $5,000 to find the total amount spent on interest per month = $62
If you pay minimum payments in this scenario, it would take 105 months to pay off $5,000. That is almost nine years!
Over that time, you would pay $2,118 in interest, and these numbers assume that you never purchase anything else with that credit card. This means the original $5,000 balance will cost you $7,118.
If you have a large purchase that you need but don't have enough money look into 0% balance transfer offers. Whether your air conditioning breaks down, need help covering moving expenses, or a medical bill. Zero percent balance transfer offers can be a great choice instead of using a normal card and paying the insane % of your normal card. Use this as a last resort and make sure to pay it off before the promotional period is over (usually 12 months) and never take out more than 30% of your overall credit card limit.
Solution: Only use your credit card to establish credit, not to use for purchase that you can't afford. Look for credit cards with 0% balance transfer offers as an alternative for big purchases. Be aware of what you're spending and make sure to not purchase more than you can afford.
Don't be like everyone else, be aware of your financial situation and make a conscious effort to improve it. Set goals like being debt free, establishing an emergency fund, or save enough for a down payment on a house. Goals will give you something to work towards instead of making one of these mistakes.
Are you currently doing some of these? Are you doing other habits that are helping you stay on top of your finances that I didn't list here? Let me know in the comments, thanks for reading!
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