Top 10 Money Mistakes (and How to Avoid Them) – Parts I and II

Making a “spending plan” and financial goals.

by Phil Dyer

A best-selling book line admonishes, “Don’t Sweat the Small Stuff”…

In most areas of life, this is true – and good – advice.  However, when it comes to your personal finances, sweating the small stuff can make the difference between success and failure.  In this multi-part series, we will explore ten of the most common money mistakes and how to avoid them.

Mistake #1: Not developing a family financial plan 

It is difficult to know how to get there unless you know where you are going.  A well-known Harvard Business School study showed that those that developed a written plan and stuck with it were 3-10 times more financially successful over a 10-year period than those who didn’t.  The basis of a family financial plan is developing specific written goals for various short, intermediate and long-term financial goals.

These goals should follow the SMART acronym – specific, measurable, attainable, realistic and timely.  For example, “I want to be rich” is not a goal, while “Accumulating $1 million in retirement assets by age 60” is.  Examples of other goals are:

• Paying off our credit card debt by July 1, 2008.
• Saving enough to cover a 4-year public college education for each of our children costing $12,000 in today’s money.
• Paying off our mortgage by age 62 for a more secure retirement.

Developing your first set of goals can be difficult, but it gets easier as you gain more practice.  Need help getting started with setting goals?  Try The 15-Second Principle (Revised Edition) by Al Secunda (Career Press, 2004).

Mistake #2: Not having a written family budget

A written family budget – simply a plan for income and spending over time – is a fundamental building block of financial success.  Unfortunately, budgets are like diets for many of us – not much fun and tough to stick with!  A better way to approach budgeting is to turn it on its head and treat it as a spending plan.

With a spending plan, you decide on your key priorities – typically your fixed “needs” – and fund those first.  With any leftover money, you tackle the “wants”, that non-essential discretionary spending.  Most financial planners recommend including funding an emergency fund and saving 10 percent of your pre-tax income in your needs list.  Samples of wants and needs include:

             Needs                                                  Wants

            Housing, food, clothing                      New cars every 2-3 years

            Medical care                                       Designer clothes

            Basic transportation                           Expensive vacations

            Emergency fund                                 Big screen TVs

            10% retirement savings                     “Money leaks”

 “Money leaks” are small, seemingly insignificant sums of money that drain many people’s bank accounts each month.  Examples include:

• Buying lunch ($7.50/day) vs. packing a lunch ($3.50/day): $4.00/day x 225 work days = $900 each year
• Gourmet coffee ($4.00 per cup) vs. brewing at home ($0.50 per cup): $3.50 per cup x 225 work days = $787.50 each year
• Vending machine sodas ($1.50 each) vs. bulk grocery store sodas ($0.42 each): $1.08 each x 225 work days = $243 each year

Just instituting these three small changes could save nearly $2,000 per year.  Investing $2,000 a year at 8 percent would grow to over $91,000 over 20 years!  Additional changes include dropping your landline and just using a digital phone ($400-600 annual savings) and avoiding ATM fees (a $2 ATM fee on a $20 withdrawal is a 10 percent fee on your money).

Mistake #3: Not having an emergency fund

“Having no money set aside [for emergencies] is like sending an engraved invitation to have Murphy move into your spare bedroom.”  Debt and financial guru Dave Ramsey

Having an emergency fund – even a small one – can be a key defense against financial difficulties should an unexpected expense arise.  Those without emergency funds are forced to use expensive credit cards, personal loans or even payday lenders to make ends meet when inevitable emergencies occur.

Most experts recommend 3-6 months of living expenses as an adequate emergency fund.  This means that an E-5 (over 6) with dependents should keep $7,000 - $14,000 in an emergency fund, while an O-4 (over 14) with dependents should have $18,000 - $36,000 in savings.  This money should be kept in a fixed-income account …but don’t let it loaf around in a low-yield bank savings account earning only 1-2 percent.

High-yield savings accounts – FDIC-insured accounts with no minimum deposit – are available from a variety of sources, including ingdirect.com (4.20% APY), hsbcdirect.com (4.50% APY) and emigrantdirect.com (4.75% APY).  These accounts are easy to set up and can be managed online from anywhere in the world (Note: APYs current as of 11/16/2007).

Couples should decide ahead of time what constitutes an emergency and agree not to tap their emergency fund unless a true emergency occurs (Hint: a trip to Cancun, new shoes or the latest golf club does not constitute an emergency).

Mistake #4: Carrying Credit Card Balances

Some of the latest news on Americans and credit card balances is not encouraging.  About half of all U.S. households (68 million) carry credit card balances from month to month, with an average balance of $9,900.  Since average credit card rates now hover around 16 percent, this means the average family carrying credit card balances is racking up $1,575 in annual interest charges!

How much does this really cost you?  Putting that $1,575 into a Roth IRA (or other savings vehicle) for 20 years earning eight percent annually would yield $72,000.  And although many of us use credit cards for convenience, recent behavioral finance studies have shown that people who use credit cards for routine purchases – even if they pay the balances off each month – spend 15-20 percent more per year than those that pay with cash or check.  It’s just too easy for many of us to buy that extra outfit or bag of groceries when using a credit card.

Here are some quick tips to reducing credit card debt:

• Pay your cards off each month
• If you find that you are building up credit card debt, put the cards away immediately and go to an all-cash budget.  Then, institute a “debt-snowball” by rank ordering your debt from lowest balance to highest balance, making the minimum monthly payments on all debts except the lowest balance and putting all extra dollars you can towards paying that lowest balance off.  Once that one is knocked out, rinse and repeat.  This is a very efficient way to pay off consumer debt.
• If you have card rates that are higher than 15-16 percent, contact the card issuer about lowering the rate or consider moving balances to a card with a lower rate to give yourself some breathing room.
• Be very careful about those “No Interest, No Payment” deals.  While it is tempting to “buy something today and pay for it tomorrow”, studies show that around 80 percent of consumers fail to pay off their balances within the typical 6-24 month grace period.  If this happens, you will owe finance charges on the entire initial balance all the way back to the initial purchase date.  For instance, if you bought a flat-panel TV costing $1,000 on a 24-month plan with a 24.9 percent finance charge, you could be hit with a whopping $640 interest charge if you didn’t pay it off in time!

Mistake #5: Buying a New Car

Many Americans buy cars using the following formula: Buy a new car, drive for 2-3 years and trade it in on another new car.  This can be a recipe for wasting hundreds of thousands of dollars over your lifetime.  Let’s look at some quick statistics:

• Most new cars lose 10-20 percent of their value as soon as they are driven off the lot
• Nearly 55 percent of new car loans are now for 60 months or more, nearly guaranteeing that the car is losing value faster than it is being paid off unless a very large down payment is made
• Nearly 34 percent of vehicle trades are “upside down”, meaning the owner owes more than the car is worth on trade-in

Instead of buying new cars every couple of years, consider the following strategies:

• Buy two to three year-old clean used vehicles through a pre-certification program
• Unless you are making a large down payment, don’t finance a vehicle for more than 42 months or the car is likely to depreciate faster than you are paying it off
• Drive the car for at least 5 years
• Do your homework by using Web sites such as edmunds.com to fully research the true value of a vehicle before putting your money down and learn about all the tricks and traps dealers use

Mistake #6: Not Saving Early for Retirement

Even if your service member plans on making the military a career, you still need to save additional money towards retirement.  As a general rule, saving 10 percent of your pre-tax income is the minimum target and the earlier you start, the better off you are.

For example, let’s look at saving $100 per month earning eight percent annually in the Thrift Savings Plan (TSP), Roth IRA or other retirement savings program starting at ages 25, 35, 45 and 55:

            Starting Age                                       Balance at Age 65

25                                                                                                                $349,100

35                                                                                                                $149,000

45                                                                                                                $59,000

55                                                                                                                $18,300

Look at the difference between starting at 25 and starting at 35.  That 10-year delay costs you $200,000 in retirement savings at age 65 … talk about expensive procrastination!  Even if you think you can’t afford it, even putting $50 or $100 away a month in a tax-deferred retirement savings plan early is critical.