Do you recognize yourself, a friend, or a family member in this list of five common personal finance blunders?
- Carrying unreasonable debt.
- Spending thoughtlessly instead of thoughtfully.
- Not saving for the future.
- Failing to invest.
- Going underinsured.
If so, we have tips for doing better.
Debt acts as a drag on personal finances. Money going out to service a debt load isn’t available for saving or investing. But some types of loans are necessary to build financial security.
Where’s the line between reasonable and unreasonable when it comes to debt?
Credit card debt is almost always considered bad, especially for those who perpetually carry a balance, because the interest rates can be as high as 30 percent. Also, the purchases many people make with credit cards are sometimes impulsive and unnecessary: vacations, restaurant meals, toys — even excess groceries.
“Overspending can happen,” said Marguerita Cheng, CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland, and a CFP® Board Ambassador. “It’s important to identify the cause and understand the circumstances.”
Of course, there can be exceptions. Using a credit card to buy one reasonably priced interview outfit to land a job, then paying off the balance after you get your first paycheck, could be considered a good use of debt.
Alternatively, conventional wisdom says that student loan and mortgage debt are types of good debt because they improve your earning potential and help build long-term wealth. Here, too, there can be exceptions.
If you borrow $120,000 to get an undergraduate degree and ultimately take a job as an administrative assistant earning $40,000 a year — a job and a salary obtainable without a degree — then your student loan debt might not be considered good debt, even if the interest rate is 5 percent and you claim a tax deduction for your student loan interest.
Similarly, mortgage debt is often considered good debt because a home can accumulate equity and increase in value over time. But a mortgage on a home you can barely afford is not good debt. High monthly payments can make it difficult to pay off other debts, meet other living expenses, or save for retirement. Refinancing or downsizing might help.
What can you do if you’ve already borrowed too much? Limit the damage. You won’t be alone. Indeed, according to a 2018 MassMutual survey , 70 percent of American families are prioritizing paying down debt. That can mean coming up with a repayment plan, refinancing, or sacrificing certain luxuries.
“The most important thing is to develop a plan of attack,” Cheng said in an interview. “You need to understand how much that debt is costing you. Sometimes, people may buy too much car. They forget to consider gas, insurance, and maintenance. Same thing with mortgages: They forget to consider utilities, maintenance, and property taxes for their home.”
Learn more: Financial goals: Debt
Most of us spend money on things that are nice to have, but not necessarily wise if you’re trying to get ahead financially. And, in many cases, there are money-saving alternatives.
- Getting the latest smartphone with a major carrier versus an older model serviced by a discount carrier.
- Buying an extras-loaded new car with dealer financing instead of getting a used car with cash or a credit union loan.
- Taking a full-blown resort vacation rather than going on a long weekend visit to see a friend or relative.
- Going out for dinner and a movie versus doing a picnic and a matinee.
- Eating lunch out versus brown-bagging it.
Taking the less expensive route can help make the difference between financial security and financial instability. Frugal moves can all add up over weeks, years, and a lifetime.
The same is true for other expenses you incur regularly.
“Revisit the services that you are paying for and what you are actually using,” Cheng said. “My kids helped me convince their dad we could ditch the landline [telephone]. As another example, do you need all of the [TV] channels you are paying for?”
Learn more: The essentials of budgeting
Maybe you’ve read that you need $1 million or $2 million or $5 million to retire. If you can only afford to save $50 per month, you might figure there’s no point in trying. Perhaps you enjoy a great sense of purpose from your work and can’t imagine ever retiring. Maybe you don’t believe in waiting until retirement to enjoy the finer things in life — you want to spend now.
Regardless of your mindset or your plans, however, you need to be saving for the future.
“Even if you can only afford to save $50 per month, the important thing is to start where you are and build the habit of saving money,” said Ashley M. Micciche , CEO of True North Retirement Advisors in Clackamas, Oregon. “Small changes can go a long way toward building life-changing habits.”
Micciche suggests starting small and focusing on what you can do today instead of focusing on the big, lofty goals that can seem insurmountable.
Saving is also important because life doesn’t always go according to plan. You can have stable work for twenty-five years, then sporadic work for the next five. Getting through those five years will be a lot easier if you’ve saved something.
Or, you could get an illness or injury that knocks you out of work, which means you lose your income and benefits — a double whammy. ( Calculator: How would a disability affect my finances ?)
Or course, unexpected things can also be good things: a business opportunity, a child, or a once-in-a-lifetime travel offer.
Saving for the future is about having cash on hand for emergencies and opportunities that may arise. And, after years of working, you may change your mind about retirement, or even want to retire early. A consistent savings plan will help make that choice possible.
Learn more: Don’t have an emergency fund? Get one
Saving is helpful, but often insufficient. Inflation erodes the value of money over time, while investments create the opportunity to outpace it.
“If you start saving $50 per month at the age of 25 until age 65, you will have $175,734 if your portfolio grows at 8 percent per year,” Micciche explained. “Not bad for $50 per month, which is doable for most people. If you can set aside $300 per month, you would be a millionaire at age 65 if your portfolio averages an 8 percent rate of return over those 40 years.”
Put that $50 a month into a savings account that pays around 2 percent interest instead and your money will be worth just under $37,000 at age 65, she calculated. And the dramatic difference between the sums you could have after 40 years comes down to the difference in returns and the power of compound interest.
“This snowball effect requires as much time as possible and a meaningful rate of return. So if you can start as early as possible and focus on investing, not just saving, you can give yourself a better chance of reaching your financial goals later in life,” Micciche concluded.
Of course, markets do retreat and investment involves risk. But, over time and with a carefully diversified portfolio, investing has proven to be a reliable way to build wealth.
Public safety nets often aren’t sufficient to get you through trying times or to fund a comfortable retirement.
Insurance can potentially fill in the vast gaps that most people can’t afford to cover themselves: replacing a totaled car, rebuilding a burned home, helping make up for lost income due to disability or illness, or providing some support when a spouse dies.
“People often overlook insurance, but insurance is an essential component of a sound financial plan,” Cheng said. “Insurance allows policyholders to transfer the risk to a third party — the insurance company. Walking around without insurance means you are assuming all of the risk.”
You may get lucky and never need to file a claim. But luck is fickle, whereas insurance carriers are regulated, rated, and even insured by bigger insurance companies for extra protection. Insurance coverage from a long-lived, highly rated, financially stable company is a lot more dependable than luck. And it can mean the difference between a comfortable life and one derailed by the financial issues raised by an unexpected problem. ( Check MassMutual’s financial strength here .)
When considering insurance, don’t forget about longevity risk. As lifespans increase, thanks to better living and medical advances, there are more concerns about outliving savings in retirement years. ( Learn more: Americans are living longer … what’s your plan? )
“As we prepare for retirement, it’s important to look at what-if scenarios and see the impact of a premature death of one spouse or partner or the cost of a long-term care event,” Cheng said.
Learn more: How life insurance can help in retirement
You don’t have to be perfect in your journey toward improving your finances. But if you avoid major mistakes and make good choices more days than not, you will be better off — more at peace, more independent, and more prepared to care for your family and for those less fortunate.
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