Financial Blunders to Avoid at all Costs
Monday, February 6th, 2012Do you ever wonder about what you can do to increase your net worth? What are the most important issues that are keeping you from accumulating and growing wealth? Which one has more of an impact on your financial well-being, investment selection or managing your cash flow?
Well, when faced with all these financial planning questions, it is easy to lose sight of the big picture. Sometimes, the little decisions can make all the difference. Here is a list of financial decisions we believe could have the most adverse impact on a person’s ability to build wealth.
- Failing to begin saving at an early age
Consider the following example:
Smart Saver begins saving $3,000 per year at age 20 and continues saving at this rate only until age 30 when he stops saving completely. At age 60, Smart Saver’s $30,000 of contributions has grown to $472,000 assuming an 8% annualized rate of return.
Late Saver begins saving $3,000 per year at age 30 and continues until he is 60 years old ($90,000 of contributions). At age 60, Late Saver has amassed only $362,000 assuming an 8% rate of return.
Not only is Smart Saver’s account worth $110,000 more than Late Saver, he has also contributed $60,000 less (a net difference of $170,000)! Saving early is a significant factor in accumulating wealth.
- Missing out on the 401(k) company match
There are very few financial lay-ups, but this is one! In many cases, by contributing 3% to your 401(k) plan your employer will match your contribution dollar for dollar. The employer match equates to a 100% rate of return on your contribution. A 100% rate of return from any investment is unheard of – take advantage of the employer match.
- Buying cars
It is a common fact that cars are depreciating assets - in order to accumulate wealth, there needs to be an emphasis on contributing to “working capital,” not depreciating assets. Every dollar you spend on automobile expenses (maintenance, insurance, property taxes and car payments) is taking away from your savings – money that could be working for you.
- Choosing a child’s education over your retirement
It’s relatively easy for a student to obtain college loans at reasonable interest rates (that are tax deductible). However, no one has ever secured a loan to cover retirement expenses. Save for your retirement first and then work on an education savings strategy.
- Using life insurance as an investment
Life insurance is not an investment, it’s insurance! The purpose of life insurance is to protect your family from the negative financial impact of a breadwinner’s death. The need to carry life insurance decreases as asset levels increase and children become independent. Universal life (UL) and variable universal life (VUL) insurance policies should be avoided. There are no exceptions to this rule.
- Changing jobs
Of course, there are times and reasons to change jobs and careers. However, there may be more costs involved than you realize. There are many factors to consider including the loss of unvested 401k balances, differences in fringe benefits, and the wait period on retirement plan eligibility. Be careful to consider the hidden costs when changing jobs.
- Taking a 401(k) distribution prior to age 59 ½
With some exceptions, taking a distribution from a 401(k) plan or IRA prior to turning 59 ½ years old is a huge mistake. Not only will you be prematurely taxed on the amount of your withdrawal, you will also incur significant penalties levied by the IRS. In most cases, taxes and penalties will consume nearly 50% of your withdrawal from retirement plans. That’s right, taking a $5,000 distribution will cost you nearly $2,500 in taxes and penalties (not to mention the future growth and tax deferral of the withdrawal) – ouch.
- Not seeking qualified financial guidance
Even for the most ardent do-it-your-selfer, there are times when qualified financial advice will pay for itself many times over. With a changing tax and financial landscape, it is impossible for the average person to make the most efficient capital allocation decisions.
