Ben Geiger, CFP®, Financial Planner
July 22, 2022
No one wants to make mistakes, especially when it comes to your money.
Unfortunately, small missteps early on can leave large lasting impacts to your finances years down the road. So, let’s take a look at mistakes that you should avoid to help set up a strong financial foundation.
1) Failure to Have a Plan
It is important to have a financial plan in place so that you can save and spend with confidence. Having a plan not only allows you to have more certainty in the decisions you make but it should also provide peace of mind knowing that you have planned for many variables. With a comprehensive plan, you can continue living the way you have despite volatility in the market or unforeseen personal circumstances.
2) Taking on Bad Debt and/or Paying Off the Wrong Debt First
If you happen to carry a high-interest debt but are making extra payments on a lower-interest debt, you may be making a big mistake. Some may say you should pay off your lowest-balance debt first then roll those payments into the next debt. However, that can end up costing you more in the long run. Being diligent about paying off your highest-interest-rate debt first will result in a lower cost of your overall debt.
Assume you have a personal loan with a balance of $25,000, term length of 60 months, and an interest rate of 7%. You also have an auto loan with a balance of $10,000, term length of 60 months, and an interest rate of 3%. The total cost of both loans if paid on schedule would be about $40,500. If you wanted to make an extra payment of $200/month and elected to apply that amount to the lower balance debt rather than the highest-interest-rate debt, the total cost of both loans would be $40,058. If that $200/month extra payment was applied to the highest-interest-rate debt first, the total cost of the two loans would be $38,922…a savings of over $1,000.
Once one loan gets paid off, help reduce your overall interest expense by applying what you were paying in monthly payments on that debt to your next highest-interest-rate debt to get it paid off more quickly.
3) Lacking an Emergency Fund
Failing to have adequate resources available in case of an emergency can put you and your family into financial trouble in a hurry. A general rule of thumb is to have three to six months of living expenses in cash. If you are a dual income household, you may be comfortable closer to the three months of cash. If you are a single income household, it may be better to hold closer to six months of living expenses in cash. We certainly understand that cash is not an attractive place to keep a lump sum of money, but it can be the most responsible.
4) Improper Asset Allocation
Improperly allocated investments can be one of the greatest detriments to a financial plan.
Let’s look at a couple in their 40s who has 25 years until retirement. They have saved $300,000 so far in their employer 401(k) and have never looked at the allocation. If that portfolio were invested conservatively and earning, on average, 4% per year, that $300,000 would be worth just shy of $800,000 in 25 years at their projected retirement age of 65. If those funds would have been in a more suitable allocation for their risk tolerance and they were comfortable being more aggressive and earning, on average, a projected 7% per year… that same $300,000 would be worth over $1.6 million!
The reverse situation is if you do not have a long time until retirement but take on too much risk, you may lose more than you can recover if there is a market downturn. Having an appropriate allocation that is in line with your goals and time horizon is imperative to your financial success.
Another factor to consider is maintaining a proper asset allocation. Neglecting to rebalance your portfolio back to the proper asset allocation can be another financial pitfall. Without systematically rebalancing your portfolio back into the target allocation, your allocation may fall out of line with the general fluctuation in the market and you may soon find yourself taking on too much or too little risk.
5) Implementing “Click Bait” Without Intentionality
Whether sitting around a table for a morning cup of coffee, or spending the day on the golf course, inevitably a friend or colleague may bring up a financial strategy they heard about in the paper, on the news, or one their financial advisor recommended. It is easy to get excited about these strategies and want to rush into implementing them.
Often it is best to run these ideas past your financial planner to ensure it is a strategy that also works well for you. No financial strategy is one-size-fits-all. There is different interest, different fact sets, and different motives behind everyone’s financial plans – ensure your strategies line up with your plan before implementation.
6) Poor Distribution Strategy
Saving money and having a proper asset allocation is important in helping create the retirement nest egg you will one day need. That can take years of hard work and diligence. Withdrawing the money is the easy part, right?! Not always. Lacking a distribution strategy may cost you valuable dollars. Having a distribution strategy can help reduce taxes and provide an efficient manner to access the funds you saved. A common mistake you could make is drawing on the wrong asset at the wrong time.
Let’s assume you need $50,000 to purchase a new car. You are in the 12% federal marginal tax bracket, have an average effective rate of 10%, and have an IRA and a non-qualified account. You decide to pull $50,000 from your IRA to pay for the car. After federal tax, you only net $45,000. However, if you were to realize gain in your portfolio, remain in the 12% tax bracket, and withdraw the $50,000 from your non-qualified portfolio, you would pay no federal income tax. To get that same $50,000 from the IRA would cost you nearly $5,555 more than if you withdrew from your portfolio in a tax-efficient manner.
With every financial decision you make, there will be consequences, good or bad! It is important to ensure the decisions you make are sound and are decisions that further the likelihood of achieving your goals and desired outcomes. Hopefully this helps you avoid these 6 financial mistakes in the future.
We have good news! If you hire a fee-only financial planning firm like Syverson Strege, you’ll have a partner who understands your goals to help make financial decisions. If you have questions about some decisions you need to make, give us a call at 515-225-6000 to talk with a credentialed financial planner.