Proper planning is crucial when it comes to your finances — not only for the decisions that can affect your wealth now but also for those that will influence your bottom line long term. But knowing how to make the best financial decisions isn’t innate. And if you don’t fully understand how to manage your finances, you’re likely to make mistakes that can take your net worth from well-cushioned to barely getting by — or force yourself to stay stuck in a constant financial struggle.
The good news is that the longer you have until your target retirement date, the easier it will be to recover from financial blunders, but what if you could avoid money pitfalls altogether? Take a look at these 15 mistakes that deplete your wealth so you can sidestep them and achieve personal financial freedom.
Not Updating and Adhering to Your Budget
If you’re interested at all in building your wealth, you already know how important it is to create a budget. However, if you don’t adjust your budget frequently based on your current income situation, your old budget isn’t doing any good. Mark your calendar to adjust your budget every six months, or whenever you have a career change. This way, you can update your savings goals, make sure your paying down debt if you have it and make bigger contributions to your savings if that’s available to you.
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Brian Stivers, investment advisor and founder of Stivers Financial Services, said that one of the biggest mistakes that depletes wealth is investing in areas you have no experience in or don’t truly understand.
“The media and internet are filled with fringe investments that promise great wealth with little risk,” he said. “Yet, many of these are extremely aggressive and have a substantial downside. It is important for those who are accumulating wealth or have already accumulated wealth to make sure they fully understand the risk involved in any new investment and how that investment works. For most investors, it makes more sense to stay with traditional investment strategies that are easy to understand and have a long track record of success.”
Buying New Cars Frequently
You might think that because you have the money, buying a new car every few years isn’t a huge problem. However, this practice can really bring down your net worth. Unless you’re paying the full amount for your car in cash, you’re adding another payment, or debt, to your portfolio. If you get a loan to buy the car, you’re paying interest on something that is actively depreciating in value. Try to only buy a new car when you need to, and pay it off as soon as you can.
Ignoring Your Interest Rates
If you have debt, you might be ashamed of looking at it each month, or you’re making the same monthly payment without thinking about it. However, the interest on your debt might be at a high rate that’s making your debt grow larger and larger. Experts recommend spending 10 minutes to review your debt terms and see if there’s an opportunity to refinance to get a lower interest rate so you’re potentially paying less each month.
Making Investments Based on Emotion
Emotions can have a powerful hold on us, but it’s important to leave them at the door when it comes to business. “Investing is emotional given the fact that money is at stake, but investors must control those emotions and aim to act on reason and rationality,” said Jason Dall’Acqua, CFP(r) and president of Crest Wealth Advisors. “Unfortunately, people tend to make investment decisions that are against their own best interests strictly for emotional reasons. The most common example is chasing trends, which results in buying high or being panic-stricken during a market decline, which results in selling low. These decisions can have a significant negative impact on long-term investment returns.”
Viewing Your Home as a Piggy Bank
Your house is a huge asset of yours, but it shouldn’t be used as a constant source of cash. “Too often, people take home equity loans when wanting to finance different objectives like purchasing a new car, making home improvements, paying off credit card debt or taking a vacation,” said Robert R. Johnson, Ph.D., CFA and professor of finance at the Heider College of Business, Creighton University. “They constantly deplete the equity they have built up in their home and are unable to build true wealth.”
Holding Unprofitable Investments
There is no point in making investments simply just to have investments. Make sure the investment is actually paying off before you start sinking money into it. “One of the biggest wealth-depleting mistakes I see is people buying and holding investment properties that lose money or barely break even for the appreciation,” said Cynthia Meyer, CFA(r), CFP(r), ChFC(r) with Real Life Planning. “The point of owning rental property is to earn net rents after expenses. If it costs you more every month to carry the investment than the net rent received, it’s not profitable – and those accumulated losses may offset or exceed any potential price appreciation. What I always tell clients is that cash flow is the cake and appreciation is the frosting. You don’t just eat frosting. You want cake with frosting.”
Neglecting To Contribute to Retirement Savings
As a young and healthy person, it might not seem pressing to contribute to your retirement account. You might think that you have plenty of time to build up a healthy savings. You’re right that you might need to contribute the maximum amount to your retirement, but you should be putting in something. Take advantage of 401(k) plans that are set up through your employer. If you don’t have that benefit, set up an individual retirement account (IRA) that you can contribute to on your own. Though 15% of your income is recommended, start with whatever you can afford and try to increase it by 1%-2% each year.
Tapping Your Retirement Accounts Early
You should not view your retirement account as an extra savings account. Treating it like an emergency fund can quickly diminish your long-term wealth. “It’s always tempting to think about tapping your retirement accounts for non-retirement expenses, such as paying off student loans, a new car, or other immediate cash needs,” said Kenny Senour, CFP professional with Millennial Wealth Management. “However, it’s important to remember that the funds you are saving in those retirement accounts are meant to be long-term investments and grow over several decades with the market. On top of that, you are looking at some significant tax penalties for tapping your retirement savings early, which has the potential to derail your progress and set you back for years to come.”
Not Having an Emergency Fund
You should always have an emergency fund on hand, no matter how much money is coming in. “When we’re doing well for ourselves in the moment, we might not be thinking of the possibility of an economic crisis like the pandemic or unexpected expenses like a car repair,” said Katie Ross, executive vice president for American Consumer Credit Counseling. “But if you prioritize saving a part of each paycheck now, you’ll thank yourself in the future. If you lose your job or have an ER bill to pay, you can lean on your emergency fund, rather than taking away from your living expenses to pay for it — or worse, relying on credit cards or loans to pay and being in debt.”
Investing In Real Estate With a Short Time Horizon
If you choose to invest in real estate, view it as an investment for the long haul. Real estate should never be used to try and make money in a short amount of time.
“Some of the greatest depletions of wealth I’ve seen in working with clients is when they begin investing in real estate in the hopes of quickly turning a profit,” Stivers said. “This is especially true in real estate markets, such as the one most of the country is currently experiencing with incredible appreciation trends. Real estate should be considered a long-term investment and not an investment to see great gains in a short period of time.”
Becoming Too Conservative With Investments When Nearing Retirement
You might think it’s smart to become more careful with your investments as you get closer to retirement, but that’s not always the case.
“Most people don’t think of being too conservative as a risk to wealth, but it certainly can be, especially during the low-interest-rate environment we’ve been in for well over a decade,” Stivers said. “Many people, as they near retirement, feel they have enough, so they move funds to CDs, high-yield savings or all low-yielding U.S. Treasuries. The net result is that they end up earning less than they are taking for retirement income and/or don’t earn enough to keep up with inflation. So, they may protect themselves against market loss but still create a wealth-depleting portfolio through interest risk.
“I recommend my clients work with a financial advisor to help them create a portfolio that can protect their assets against market loss (risk management), have stable growth potential (investment management), have dependable income strategies (retirement income planning) and protect the spouse at the first death (legacy planning).”
Lack of Diversification Across Net Worth
Diversification in your portfolio is very important to build up wealth. “Many individuals believe they are investing through the real estate they own, the majority being their primary residence. This is not diversification from a wealth manager’s perspective and has a high concentration risk to the real estate market,” said Craig Borkovec, a financial advisor at Miracle Mile Advisors. “Diversification for wealth managers would include not only real estate but also investment assets in public markets and private markets or insurance policies to cover shortfalls in the event of death, disability or long-term care. These are a few ways to help diversify your overall net worth and minimize risk throughout your life.”
Spending Too Much To Start a Business
When you have a business idea, you might be tempted to go all in. That might mean taking out loans and spending tens of thousands to get your dream business up and running. What that could lead to is mounds of debt that takes years to pay off. About 42% of CEOs reported spending about $5,000 or less on start up costs. This ensures that once your business does get going, you’re able to make a profit faster, rather than scrambling to pay off all the debt you accrued starting the venture.
Expanding Your Business Too Quickly or Unnecessarily
Your small business might be doing very well, and you might be tempted to expand, however, Stivers said you need to be really thoughtful when considering expansion. “[Expansion] has been the number one reason I’ve seen business owner clients lose their wealth. The expansion comes at the wrong time economically, or they branch out into territory they don’t fully understand. I recommend if the current business can grow incrementally and it is already providing wealth accumulation, that business owners consider being the best they can be in the current situation and to be satisfied with what they have.”
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Sam DiSalvo contributed to the reporting for this article.