People usually contact us with a problem or a worry. They may have just gotten married and are wondering how in the world they can afford to buy their first house. They may have been working for years, put their kids through college and are now wondering if they will ever be able to retire. They may have been good savers or poor savers. They may have been big spenders or frugal. After advising people for more than 20 years, I’ve seen a lot—both good and bad. Here are my top 5 financial mistakes to avoid.
1. Not having an Emergency Fund
What is an Emergency Fund anyway? It’s a cash account, usually at an FDIC-insured bank1, that you never touch. Never touch, really? Yes, really! If you tap into it every month the account is clearly not for emergencies. Why is that important? Emergencies inevitably come up from time to time: your car breaks down or dies, your roof starts leaking, or you get laid off from your job. Most of the time these events are not expected and can have a big financial impact on you.
If you have an Emergency Fund, you’ll be going to “The Bank of Me” instead of having to put it on your credit card or borrowing at a high rate of interest. Another aspect of Emergency Funds that I really like is that you will sleep so much better when you have a good amount of cash stashed away for a rainy day. It’s security.
2. Having no idea how much you spend each year
Knowledge is power as they say and knowing how much you are spending is important to understanding if you will be able to achieve your financial goals—or not. When you get your first job out of college, keeping track of spending tends to be relatively straightforward. But when you get married, start having kids, start a business or invest in real estate, it is easy to lose track of where all the money goes.
You don’t have to be an accountant to keep track. I encourage people to use a “back of the envelope” approach to regularly summarize major expense categories. This time of year (in the first quarter), credit card companies typically publish a year-end summary. These reports are already categorized for you. They are not perfect, but they are a great start to seeing where your money goes. Many times, when we are totaling up a person’s expenses, I hear something like, “I had no idea we spent so much money on…(pick a category).”
3. Spending more than you earn
If you don’t know how much you are spending, this one is impossible to know. That’s why you need to figure out where all of your money goes and you need to compare it to your income, after taxes. If your after-tax income2 is greater than your spending, you’ll have some money left over to save for the future—future things like a vacation this year, a car replacement next year, a home down payment in three years and, of course, a happy retirement someday.
Big spenders tend not to want to know if they are spending more than they earn. I think that is because they fear that the answer is pretty bad. That can lead to worrying more about money and sometimes even more spending to forget about it. You’ve heard of retail therapy, right? I’m pretty sure it is not the kind of therapy that leads to long term financial security and happiness.
Over the holiday break, I’ve had a financial meeting with each of my young adult children. They are just starting to learn about money and I want them to understand one of the simplest, yet often the most difficult, financial rules to a happy life: “Always spend less than you earn.” I told them that if they remember nothing else from dad about finances, they should remember that phrase. It is so important that I am thinking of making it into a bumper sticker and giving them away!
4. Not paying off your credit card balance in full each month
I see this most often with young people who are impatient about traveling or dining out with friends. It can be a big temptation, especially if you work long hours, are stressed at work or home, and feel like you don’t have any time. After all, if someone gave you the option to have fun today or do something somewhat uncomfortable every month for a year (e.g., saving a set amount each month for a future vacation), most would just take the vacation now. Credit card companies have built their businesses around this kind of immediate gratification. They want you to believe that “you deserve it.” While you likely do deserve it, YOU should take charge of your finances—not the credit card companies.
5. Not saving for retirement
I’m pretty sure almost everyone knows that they need to save for retirement, but many people let too many expenses get in front of that long term goal. If you are young, why save now? Because if you wait until you are making enough money (whenever that is), years will likely have passed if not decades and then, suddenly, you will have to play catch up in a big way. I have seen this play out with several couples and individuals in their 50s. Finally, they come around to the idea that they would like to retire someday and they don’t want to have to work until they day they die. If they have not been regular savers, they have missed out on the benefits of compounding and have far fewer choices to course correct. That doesn't mean it can’t be done. It just means that they will likely have to save and invest more diligently at a time when their friends are out having a good time.
If you have any of these concerns, give me a call. All is not lost, especially if you are willing to be flexible or make a commitment to achieve your goals. I can help you get there. You can schedule a quick call with me by clicking HERE.
Lyman H. Jackson
· The 2 most avoided financial topics https://planwithfps.com/blog/the-2-most-avoided-financial-topics
· Wait. You can help me with that? https://planwithfps.com/blog/wait-you-can-help-me-with-that
· Teaching kids to be financially responsible https://planwithfps.com/blog/teaching-kids-to-be-financially-responsible
1 There are many online only financial companies today such as PayPal that offer high yield accounts. Be careful. Many are not banks and your deposits are not insured by the Federal Deposit Insurance Corporation. That means if the company gets into trouble, no government agency is going to step in to make sure you get your money back.
2You can use your paycheck after taxes have been deducted for after-tax income.
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.