Financial blunders are made all the time and everywhere
– at the grocery store, at the bank, in the housing market, in the
stock market, with your children’s allowance. Some stem from a lack of
knowledge or awareness, while others are the result of human behavior
that often works against our own best interests. The worst mistakes you
can make, though, usually involve those that seem harmless but end up
impacting your overall wealth.
We spoke with financial advisers about the worst financial slip-ups people make and how much they can cost you. No doubt the opportunities to mishandle your money are endless, and this list is by no means exhaustive. But here are some money moves you should strive to steer clear of.
1. Spending an unexpected windfall. All of it.
Two-thirds of baby boomer households will likely receive some inheritance, with a median amount of $64,000, for a total prospective inherited amount of $8.4 trillion, according to research published in 2011 by the Center for Retirement Research at Boston College. A big challenge for many inheritors, though, is that they can be completely inexperienced with money. And with inexperience and poor – or no – planning, comes the potential for squandering a windfall.
Americans spend their inheritance shockingly fast, says Mackey McNeill, a CPA in Bellevue, Ky. “When people get a big amount of money that they didn’t earn, they feel like it’s so much money, they’ll never run out,” she says.
McNeill recounted the story of a client whose mother had died and left her about $500,000. “By the time she walked in my door, she only had half of it left," McNeill says. "She paid off some of her mortgage, bought a new car, donated some money and bought a big-screen TV for her son” while having the unrealistic expectation of being able to quit working and pay for her son’s college tuition. “You need to run the numbers before spending it," adds McNeill. "If they keep that capital and invest it, they can generate income for the rest of their lives."
2. Cashing out of your 401(k) when you leave your job
Among workers who left their jobs in 2012, 43% took a cash distribution, up slightly from 42% in 2010, according to yet-to-be-released data from Aon Hewitt, a human resources consultancy. And the smaller the balance in the plan, the more likely it is that participants will cash out when they leave. But taking money out of your plan before retirement is going to cost you; you’ll get hit with a 10% early-withdrawal penalty (if you’re younger than 59 ½) and get taxed on the sum. And possibly more serious, you lose the earnings that money could have generated.
Consider this example from Aon Hewitt of an employee who cashes out of three employer-sponsored 401(k)s over 30 years of working and retires at 65. Assume she saved 8% of her pay, got a 5% match per year, earned 3% annual salary increases on a starting salary of $50,000, and earned 7% in investment returns a year. After factoring in taxes, penalties and lost interest, she’d accumulate $189,000 in her account by age 65. If she didn’t touch the money at all, however, she’d have $872,000 – the cash-outs would have cost this saver almost 80% of her nest egg.
Upon leaving, many advisers have traditionally recommended rolling a 401(k) into an IRA, in part because IRAs offer a wider range of investment options than a typical employer’s 401(k). More recently, some employers are offering a stronger selection of investment options in their 401(k) plans, says Avani Ramnani, CFP and director of financial planning and investment management at Francis Financial in New York, but the decision to roll funds into another 401(k) or an IRA also depends on how savvy of an investor you are. If you’re comfortable selecting investment options and know how to allocate funds, the IRA offers a great opportunity. But if you’re less experienced, selecting some low cost index-based options from an employer’s plan may make more sense, Ramnani says.
3. Stopping contributions to your 401(k) plan when the market – or your account – drops
These plans are the main investment vehicle that will fund the bulk of many Americans’ retirements. There’s a reason your 401(k) automatically takes money out of your check each time you get paid – if it were up to you to set aside 5% of your pay, you’d never do it. Employee participation in 401(k) plans increased dramatically after the passage of the Pension Protection Act of 2006, which made it easier for companies to auto-enroll their employees, according to a paper published by the Center for Retirement Research at Boston College last year.
The only real reason you would shut down your contributions is if you’ve got enough retirement savings already. “I still have people telling me they’ll stop contributing to their 401(k) because it’s going down," says Steve Burnett, CFP and financial adviser at Hanson McClain, a firm in Sacramento. "And the investments might be fine. You have to understand stock prices aren’t static; what you’re hoping for is over time, is that you acquire a mass of savings to live off.”
And you’ve heard it before – you’re giving up free money when you don’t contribute to your 401(k): the matching contribution from your company (if they offer it). Say you earn $60,000 a year and your company matches 50% of your contributions up to 6% of salary. Stop participating and you’re giving up $1,500 bonus (if you contributed 5% of your salary) or $3,000 (if you contributed 10% of your salary).
4. Succumbing to lifestyle inflation
A 10% salary bump shouldn’t always equate to a 10% increase in your shoe budget or upgrading to the pricier health club. Of course, a splurge is fine, but try to resist the temptation to adjust your lifestyle upwards – or succumb to what some pros call lifestyle inflation.
Taking a $2,000 vacation is a one-time expense. Moving into an apartment that costs $150 more per month is a new and “permanent” expense that becomes part of your lifestyle cost. If we’re not careful about raising the bar on lifestyle costs, we’re likely to ramp it up so high that eventually we’ll be unable to manage the occasional speed bumps that come our way, says Michael Kitces, a CFP and director of research at Pinnacle Advisory Group in Columbia, Md. “We also end up with a lifestyle that requires an extraordinary pile of money to afford in retirement,” he says.
5. Using home equity to invest in the stock market
If you’re a good way through paying down your home mortgage, and with rates so low (last week Freddie Mac said the average 30-year fixed rate fell to 3.43% from 3.54%), doesn’t it make sense to take some equity out of your house and sink it into the market? “I’m getting people who ask about this, saying ‘my home price is pretty stagnant – shouldn’t I take money out of my home and invest it?’” says Burnett.
The problem with this approach is that the stock market is at multi-year highs at the moment – exactly the wrong time to enter the market, as most pros will tell you. Homeowners should pay down the remaining mortgage so that, when they leave the workforce, they’re not burdened by it. “If you pay X amount on your mortgage for a certain number of months, you’ll get a certain outcome. If you invest in the market, it’s uncertain you’d make money,” says Burnett. “Most of our clients are retired, and the ones doing well are those who paid down their house and were debt free.”
Source(http://finance.yahoo.com/blogs/the-exchange/5-worst-things-money-184739197.html)
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