7 Critical Financial Decisions That Determine Your Wealth

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It’s said that hindsight is 20/20, but by then, it’s often too late to change things. Wouldn’t it be nice if you could know ahead of time exactly how the big financial choices you make will affect your wealth?

While it’s not possible to consult a crystal ball and see into the future, you can make yourself aware of the critical financial decisions that can significantly impact your bottom line.

Electing (or Not) To Participate in an Employer’s 401(k) Plan

Robert R. Johnson, Ph.D., CFA, CAIA, professor of finance at Heider College of Business, Creighton University, said that one of the most important financial decisions people make is to participate in an employer-sponsored retirement plan.

“Perhaps the worst financial mistake anyone can make is turning down free money,” he said. “If one does not contribute enough in a 401(k) plan that has a company match to earn that match, one is basically turning down free money. Many people put such a high priority on paying down debt or buying a home that they do not participate in their company 401(k) plan.

“Contributing the max to your 401(k) also reduces your tax bill. People should do whatever it takes to participate in their company’s 401(k) plan to the level to get the full employer match.”

Johnson said that the opportunity loss of not participating in an employer-matching program is substantial. “If you have a 100% employer matching program, you are essentially electing to turn down the equivalent of 100% of what your own contributions would grow to,” he explained.

Asset Allocation Decisions in a 401(k) Plan

Johnson said he always tells his students that one of the most important financial decisions they can make in their life is how to allocate contributions to their 401(k) plan.

“Too often, individuals are overly conservative with their asset allocations,” Johnson explained. “And the problem is that once the choice is made, people very rarely revisit it. Behavioral research indicates that inertia sets in and people are hesitant to change their initial allocations. This results in a big opportunity loss to people because of time and compounding.”

Johnson said that people need to be taught to invest for retirement — not save for it. He said that the most certain path to building true long-term wealth is to invest in the stock market.

“Mistakes begin early in life, and the biggest financial mistake people make is taking too little risk, not too much risk,” he said. “In fact, a UBS study showed that millennials and the World War II generation have similar asset allocations — low allocations to equities and inordinately high allocations to cash. Both generations were shaped by cataclysmic financial events in their formative years — the WWII Generation with the Great Depression and millennials with the Financial Crisis. Millennials need to begin compounding early, and let that compounding work its patient magic over decades.”

Overinvesting in a Home

Johnson said that, historically, residential real estate has proven to be a poor investment when compared to alternatives. This is especially true, he said, when people opt for a mortgage that’s close to the maximum of what they can afford and end up crowding out investments that could prove more lucrative, like stocks.

“According to data on home prices compiled by Nobel laureate Robert Shiller, home ownership is not a very effective way to accumulate long-term wealth, despite conventional wisdom suggesting the contrary,” Johnson said. “Many people continue to believe the myth that residential real estate is the best long-term investment, and the evidence simply suggests otherwise.

“People fall prey to the stories of individuals realizing substantial gains by buying a home and selling it at a much higher price years down the road. The fact that, in the United States, a large percentage of an individual’s net worth is concentrated in home equity adds to the mistaken belief. Specifically, according to 2021 data, the U.S. Census Bureau found that 28.5% of U.S. household wealth was concentrated in home equity.”

Johnson explained that many people don’t think about all the costs of homeownership beyond the mortgage, including property taxes, insurance and upkeep.

“Robert Shiller makes a compelling case that real estate, particularly residential homes, are a much inferior investment when compared to stocks,” Johnson said. “Shiller finds that from 1928 through 2021, the annualized return (compound annual growth rate) on residential real estate based upon price changes was 4.2%. Over that same time period, U.S. large cap stocks returned 10.2%. In addition, stocks do not need a new furnace, a lawn mowed or a new roof, and they do not require annual property tax payments.”

Having Children

Chris Urban, CFP, RICP, founder at Discovery Wealth Planning, said that if you choose to have children, your net worth is likely to be less than if you did not have children.

“Of course, this is strictly speaking from a financial perspective,” he said.

Choosing Where You Live

“Cost-of-living varies dramatically around the United States and around the world,” said Urban. “You would likely be able to increase/decrease your net worth substantially by living in a lower/higher cost-of-living area.”

Education

“Whether you choose for you and your family to go to public school(s), private school(s) or no school(s) will likely have some impact on your net worth,” Urban said. “Of course, less investment in education will at least initially increase net worth; however, over the long-term, this may negatively impact your earning power and the ability to increase your net worth.”

Gifting

Urban said that later in life, people tend to give more thought to legacy goals and gifting to family or charities.

“Some people enjoy gifting while they are alive so that they can see the benefit of their gift(s), while others choose to donate at death,” he said. “Either way, gifting could have an impact on your net worth.”

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