The Ten Most Common Personal Finance Mistakes

We all commit some of these unforced errors

It’s impossible to dodge all the financial potholes that await us. The best we can hope is to: (1) make the mistakes when the consequences are small and (2) learn from them and move on.

We’re all human and thus emotions play a big role in our financial decision-making. As my daughter aptly observed, “When it comes to personal finance, it’s usually more about the personal than the financial.”

Here are the ten (okay, 11 or 12) most common errors I see:

1. Too risk-averse

We get rattled by the ups and downs of the stock market and respond by investing too conservatively. It’s easier to sleep at night but it’s not a winning long-term strategy. The stock market compounds at a long-term rate of ~10%; high yield savings or CDs are more like 3% over the long-term. That’s the difference between your money doubling in 7 years versus 24 years.

Warren Buffet’s partner, Charlie Munger famously quipped, “The first rule of compounding is to never interrupt it unnecessarily.”

Easy to say, hard to do.

2. Too much complexity

We have too many accounts and too many investment positions. And, we believe that owning several versions of a similar investment offers better diversification and safety. Uh, no.

Instead, keep it simple, especially as you age. Consolidate all your old retirement accounts, get rid of the multiple savings accounts, and just invest in low-cost index and/or money market funds. Target date funds for your retirement account are even simpler.

3a. Too much employer equity

Equity-based compensation from your employer is great — stock options, RSUs, ESPP, etc. — but why hold on to it after it vests?

To use a fancy term, you’re “over-indexed” to the fate of your employer so why concentrate even more of your wealth by retaining this stock? Sell it when you can and invest the proceeds elsewhere to diversify your portfolio. (See next point.)

3b. Too undiversified

Closely related to the previous point is to not diversify your investments. With target date and low-cost index funds, it’s quite easy to do. Instead, I see too many people with disproportionate amounts of the net worth in a single stock or two.

Whether you’ve fallen in love with the stock and are a true believer or just don’t want to pay the capital gains tax that would result from selling the shares and diversifying, this is dangerous. Everything is fine until it isn’t.

4. Too oblivious to investment expenses

Investment fees add up and substantially erode your accumulated net worth over time.

These expenses are well-hidden but if you minimize them, you’ll have more money when you retire.

5. Too oblivious to investment taxes

Taxes also matter. Pay what you must but no more. Invest in tax-efficient funds and maximize the use of tax-advantaged accounts such as 401Ks, Roth IRAs, 529s, and HSAs. Also, be smart when realizing capital gains, harvesting losses, doing Roth IRA conversions, etc.

As with fees, this can have a big payoff over time as the only net worth that matters is what you keep after you’ve paid your taxes.

6. Too much trust

Don’t be in awe of financial expertise. Yes, it’s knowledge you don’t have just like other professionals such as plumbers, surgeons, and car mechanics. Assume positive intent but remember, the experts are looking out for their interests, just like the rest of us.

So, be skeptical, curious, do your homework, and seek a second opinion. Or, as Ronald Reagan said, “Trust but verify.”

7. Too much spending

Most of us don’t know what we spend and don’t have a target. Also, when we do tally it up, it’s almost always more than we thought.

Track your total spending each month so you don’t over-spend. If this makes you anxious before spending, that’s a feature not a bug.

8. Too much borrowing for college

Don’t break the bank for your kids’ college education. Don’t risk your retirement, your home, or you kids’ future by overborrowing.

And similarly, don’t over-borrow for graduate school.

Set expectations and boundaries with your kids or you’ll regret it later. Hoping it will work out because they “deserve it” is not a good strategy.

9. Too much belief in real estate as a wealth creation tool

Residential real estate is not the best asset for wealth creation. There are lots of good reasons to own your home but they’re not financial ones. Buy a home if your circumstances are right but not because you think it’s the fastest way to get rich.

If that’s your goal, you’ll get there faster if you dodge these first eight mistakes, rent instead of buy, and invest your savings in low-cost and tax-efficient index funds, instead of a down payment.

10. Too early to claim Social Security

In most circumstances, wait until age 70 to claim Social Security. Most of us don’t.

Social Security is the world’s greatest annuity with a built-in spousal benefit, an inflation-adjustment, a generous multiplier for each year you delay, and a rock-solid guarantor. Unless you and your spouse don’t expect to be around for very long, you’ll maximize its lifetime value if you delay until age 70.

11. Too short-term

Lastly, it’s hard to keep a long-term focus — it’s far away, abstract, uncertain, and there are pressing demands now. We undervalue the future but, if you don’t plan for it, you may not enjoy it much.

Most of us don’t have:

• enough retirement savings

• an adequate emergency fund

• an up-to-date will

• sufficient life insurance

Instead, we hope that things will work out to be just fine. They may, but it’s a risky way to go through life.

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