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 do is: (1) make the mistakes when the consequences are small and (2) learn from them and not keep tripping over the same ones.
We’re all human and thus emotions play a big role in our financial decision-making. As my daughter has aptly observed, “When it comes to personal finance, it’s usually more about the personal than the financial.”
Here are the ten (okay, 11) 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.
Warren Buffet quipped, “Be greedy when others are fearful and fearful when others are greedy.” Buffet’s partner, Charlie Munger had his own folksy version, “The first rule of compounding: Never interrupt it unnecessarily.”
Easy to say, hard to do.
2. Too much complexity
We have too many accounts and too many investment positions. People also believe that owning several versions of a similar investment offers better diversification and safety. Not really.
Instead, keep it simple. 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.
3. 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 risk.
4. Too oblivious to investment expenses
Investment fees and expenses add up and substantially erode your accumulated net worth over time.
They’re hard to find but if you minimize these expenses, 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 as with other expertise you may lack 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 and curious, do your homework, and seek a second opinion. Or, as Ronald Reagan famously 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.
Have a target and track it monthly 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.
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 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 just not financial ones. Buy a home if the circumstances are right for you 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 spend less and invest your savings in low-cost and tax-efficient index funds.
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
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 that’s a risky way to go through life.