6 Money Mistakes—and How to Avoid Making Them
Photo: Deborah Feingold
Mistake #1: Putting Your Faith in the Traditional Definition of "Good Debt" vs. "Bad Debt"
Most of us grew up thinking that if you borrow to purchase things that go up in value—like a home—or to invest in things that will improve your future earning power—like a college education—the result is "good" debt. "Bad" debts were credit card balances, evidence that you borrowed money to buy stuff that would go down in value (clothes, cars, vacations—you name it). The conventional wisdom might be okay for good times, but we aren't in good times. Not only does the average American household carry about $15,000 in credit card debt, even now, several years after the Great Recession started, people continue to lose their homes to foreclosure.
The Fix: Here's the truth: Debt is debt. Probably the most important lesson of the recession is that the only difference between good debts and bad debts is that the bad variety can destroy your financial life more quickly. Now don't get me wrong; without a lending industry, we could not function as a society, and borrowing to build assets can make sense—if you have a real plan to repay your debt. But I believe that in today's economy, getting out of debt fast is the most important financial move you and your family can make. The faster you are debt free, the faster you are really free.
Mistake #2: Giving Up Instead of Getting Going!
For many of us, our biggest problem isn't the economy or even the state of our finances. It's fear. Fear of the unknown. Fear of what might happen next. Given the grim news about the economy—job losses, homes still worth less than the mortgages on them—people are letting themselves believe that they have no control over their financial situation and no hope for a richer future.
The Fix: Today's economy presents an amazing opportunity to hit the reset button on your life, both personally and financially. It doesn't matter what kind of a beating you've taken. What you do now will determine the kind of life you will have for years to come.
The key is to stay motivated. To keep positive momentum, I suggest you surround yourself with like-minded people who want to take back their lives. One of my favorite success stories is from a woman by the name of Genevieve, who created a support team at work that used my DOLP™ (Done on Last Payment) system to help pay down their debts. They worked together to keep each other motivated. Genevieve repaid over $70,000 with the support of her team. She's proof that no matter where you are and no matter where the world is, you can take control of your finances with the right mind-set, influences and tools.
Most of us grew up thinking that if you borrow to purchase things that go up in value—like a home—or to invest in things that will improve your future earning power—like a college education—the result is "good" debt. "Bad" debts were credit card balances, evidence that you borrowed money to buy stuff that would go down in value (clothes, cars, vacations—you name it). The conventional wisdom might be okay for good times, but we aren't in good times. Not only does the average American household carry about $15,000 in credit card debt, even now, several years after the Great Recession started, people continue to lose their homes to foreclosure.
The Fix: Here's the truth: Debt is debt. Probably the most important lesson of the recession is that the only difference between good debts and bad debts is that the bad variety can destroy your financial life more quickly. Now don't get me wrong; without a lending industry, we could not function as a society, and borrowing to build assets can make sense—if you have a real plan to repay your debt. But I believe that in today's economy, getting out of debt fast is the most important financial move you and your family can make. The faster you are debt free, the faster you are really free.
Mistake #2: Giving Up Instead of Getting Going!
For many of us, our biggest problem isn't the economy or even the state of our finances. It's fear. Fear of the unknown. Fear of what might happen next. Given the grim news about the economy—job losses, homes still worth less than the mortgages on them—people are letting themselves believe that they have no control over their financial situation and no hope for a richer future.
The Fix: Today's economy presents an amazing opportunity to hit the reset button on your life, both personally and financially. It doesn't matter what kind of a beating you've taken. What you do now will determine the kind of life you will have for years to come.
The key is to stay motivated. To keep positive momentum, I suggest you surround yourself with like-minded people who want to take back their lives. One of my favorite success stories is from a woman by the name of Genevieve, who created a support team at work that used my DOLP™ (Done on Last Payment) system to help pay down their debts. They worked together to keep each other motivated. Genevieve repaid over $70,000 with the support of her team. She's proof that no matter where you are and no matter where the world is, you can take control of your finances with the right mind-set, influences and tools.
Mistake #3: Having a 30-Year Mortgage
After the recent disasters we've seen with the adjustable-rate deals that have gotten so many people in trouble, many homeowners and new buyers are turning to 30-year fixed mortgages. But take a look at the closing paperwork for your mortgage. (If you don't already own a home, ask a good friend or family member for theirs.) Near the top you'll find two numbers: the amount of the loan and the amount to be paid to the lender at the end of three decades. For example, you buy a home for $250,000 with a 30-year mortgage at 8 percent, and you'll wind up paying about $660,000. Where did the extra $410,000 in interest go? It went right into your lender's pocket.
The Fix: First thing, if you plan to be in your home for more than five years and you have an adjustable-rate loan, then you should refinance now. Rates are at historic lows as I write this in July 2011—but they won't last forever. Second, if you can manage the higher monthly payments, signing up for a 15-year fixed mortgage is the way to go—no question. Not only will you be free of your mortgage debt sooner, but you will save a lot of money in the process.
If a 15-year mortgage is just too expensive, I recommend you change the way you tackle your 30-year fixed-rate mortgage. Instead of making one payment per month, send half your monthly payment every two weeks. In a 52-week year, you'll end up making 26 half payments—essentially one extra mortgage payment a year. It may not seem like a lot, but the impact of that one change is awesome: Depending on your interest rate, you could pay off your mortgage 5 to 10 years early and save more than $100,000!
Mistake #4: Letting Existing Lines of Credit Close or Closing Them Yourself
Most of us have figured out that credit card debt can be a slippery slope. You may have even made the decision to stop using one or more of your cards and stowed them away. That may have worked in prior years, but in the aftermath of the credit crunch, the credit card industry has gotten much stricter about inactive accounts—and they can decide to close them. This can hurt your credit score, since it reduces the average age of your credit accounts. If you close old accounts yourself, you're shortening your credit history and reducing your total credit—neither of which is good for your score. Also, closing an old account will not remove a bad payment record from your report. Closed accounts are listed right along with active ones.
The Fix: For now, hang on to your old accounts and start putting at least one charge on each of them every month. But please note: This strategy depends on being vigilant with your credit cards, paying the full balance and not missing any payments. This will keep your account open, which in turn will keep your credit history nice and long—and ultimately raise your credit score. (If you have to close an account, close a relatively new one.)
Mistake #5: Giving Up on Your Retirement Plan
Of all the terrible ways that the Wall Street meltdown affected our lives, one of the most painful involves our retirement savings. Although more than 50 million Americans are putting aside money for retirement in one way or another, most people's 401(k) accounts and individual retirement arrangements took a major hit over the last few years—some investors lost close to a third of the value of their retirement plan.
Nearly four out of 10 workers who responded to a 2009 AARP survey said that they'd cut back the amount of contributions to their accounts. Even worse, one in five workers over the age of 45 said they had cut out their retirement contributions entirely.
The Fix: Given the economic surge that usually follows a deep recession, you couldn't pick a better time than today to recommit to a wealthy future by saving and investing for retirement. If your employer offers a 401(k) or similar retirement plan, make sure that you're signed up and contributing. If you don't have a 401(k) at work, then you should open your own IRA. You can use websites like Morningstar.com to compare your investments' performance to others in the same asset class. If you do not feel comfortable making these decisions yourself, get some help from a qualified financial professional. (Start with your employer; they might offer a free or fee-based advisory service.) I also suggest you try increasing your retirement contributions today; if you don't feel the pinch, raise them some more. A great strategy is to start by saving a minimum of 5 percent—or the amount up to which your employer will match—and then gradually increase it to at least 10 percent. Your goal is to reach the maximum contribution allowed each year and to make sure you're paying yourself first!
After the recent disasters we've seen with the adjustable-rate deals that have gotten so many people in trouble, many homeowners and new buyers are turning to 30-year fixed mortgages. But take a look at the closing paperwork for your mortgage. (If you don't already own a home, ask a good friend or family member for theirs.) Near the top you'll find two numbers: the amount of the loan and the amount to be paid to the lender at the end of three decades. For example, you buy a home for $250,000 with a 30-year mortgage at 8 percent, and you'll wind up paying about $660,000. Where did the extra $410,000 in interest go? It went right into your lender's pocket.
The Fix: First thing, if you plan to be in your home for more than five years and you have an adjustable-rate loan, then you should refinance now. Rates are at historic lows as I write this in July 2011—but they won't last forever. Second, if you can manage the higher monthly payments, signing up for a 15-year fixed mortgage is the way to go—no question. Not only will you be free of your mortgage debt sooner, but you will save a lot of money in the process.
If a 15-year mortgage is just too expensive, I recommend you change the way you tackle your 30-year fixed-rate mortgage. Instead of making one payment per month, send half your monthly payment every two weeks. In a 52-week year, you'll end up making 26 half payments—essentially one extra mortgage payment a year. It may not seem like a lot, but the impact of that one change is awesome: Depending on your interest rate, you could pay off your mortgage 5 to 10 years early and save more than $100,000!
Mistake #4: Letting Existing Lines of Credit Close or Closing Them Yourself
Most of us have figured out that credit card debt can be a slippery slope. You may have even made the decision to stop using one or more of your cards and stowed them away. That may have worked in prior years, but in the aftermath of the credit crunch, the credit card industry has gotten much stricter about inactive accounts—and they can decide to close them. This can hurt your credit score, since it reduces the average age of your credit accounts. If you close old accounts yourself, you're shortening your credit history and reducing your total credit—neither of which is good for your score. Also, closing an old account will not remove a bad payment record from your report. Closed accounts are listed right along with active ones.
The Fix: For now, hang on to your old accounts and start putting at least one charge on each of them every month. But please note: This strategy depends on being vigilant with your credit cards, paying the full balance and not missing any payments. This will keep your account open, which in turn will keep your credit history nice and long—and ultimately raise your credit score. (If you have to close an account, close a relatively new one.)
Mistake #5: Giving Up on Your Retirement Plan
Of all the terrible ways that the Wall Street meltdown affected our lives, one of the most painful involves our retirement savings. Although more than 50 million Americans are putting aside money for retirement in one way or another, most people's 401(k) accounts and individual retirement arrangements took a major hit over the last few years—some investors lost close to a third of the value of their retirement plan.
Nearly four out of 10 workers who responded to a 2009 AARP survey said that they'd cut back the amount of contributions to their accounts. Even worse, one in five workers over the age of 45 said they had cut out their retirement contributions entirely.
The Fix: Given the economic surge that usually follows a deep recession, you couldn't pick a better time than today to recommit to a wealthy future by saving and investing for retirement. If your employer offers a 401(k) or similar retirement plan, make sure that you're signed up and contributing. If you don't have a 401(k) at work, then you should open your own IRA. You can use websites like Morningstar.com to compare your investments' performance to others in the same asset class. If you do not feel comfortable making these decisions yourself, get some help from a qualified financial professional. (Start with your employer; they might offer a free or fee-based advisory service.) I also suggest you try increasing your retirement contributions today; if you don't feel the pinch, raise them some more. A great strategy is to start by saving a minimum of 5 percent—or the amount up to which your employer will match—and then gradually increase it to at least 10 percent. Your goal is to reach the maximum contribution allowed each year and to make sure you're paying yourself first!
Mistake #6: Not Taking Advantage of Automating EVERYTHING
I have preached the importance of "making it automatic" for years, but I still see so many people paying bills the old-fashioned way. (Okay so this isn't a new mistake, but it's an even bigger mistake now that we have so many electronic options for managing our money.) When you don't automate your finances, you may forget to pay your bills on time, which, as I've mentioned, will not only negatively affect your future interest rates and credit score but will also cost you a fortune. If you miss a payment on an account with a $500 balance, the late fee could be as much as $50. If you exceed your credit limit at the same time, the fee could be $100. In my experience, many people who haven't automated their finances tend to have underfunded savings accounts, leaving them financially unprepared for an emergency, retirement or helping with their children's future.
The Fix: Bottom line: The one way to create lasting financial change that will help you build real wealth over time is to...make your financial plan automatic!! Set up direct deposit for your paycheck so that you don't have to waste any time going to the bank; also set up an automatic payroll deduction to fund your retirement account, ensuring that you remember to pay yourself first. Finally, use your bank's online bill-paying service to automatically take care of your monthly minimum credit card payments and other bills. Follow the steps listed in the Automatic Millionaire 2.0 diagram—and you will truly have a foolproof, no-brainer "set it and forget it" financial plan that, I promise you, will work.
David Bach is the author of Debt Free for Life: The Finish Rich Plan for Financial Freedom and founder of FinishRich.com.
More Personal Finance Advice
I have preached the importance of "making it automatic" for years, but I still see so many people paying bills the old-fashioned way. (Okay so this isn't a new mistake, but it's an even bigger mistake now that we have so many electronic options for managing our money.) When you don't automate your finances, you may forget to pay your bills on time, which, as I've mentioned, will not only negatively affect your future interest rates and credit score but will also cost you a fortune. If you miss a payment on an account with a $500 balance, the late fee could be as much as $50. If you exceed your credit limit at the same time, the fee could be $100. In my experience, many people who haven't automated their finances tend to have underfunded savings accounts, leaving them financially unprepared for an emergency, retirement or helping with their children's future.
The Fix: Bottom line: The one way to create lasting financial change that will help you build real wealth over time is to...make your financial plan automatic!! Set up direct deposit for your paycheck so that you don't have to waste any time going to the bank; also set up an automatic payroll deduction to fund your retirement account, ensuring that you remember to pay yourself first. Finally, use your bank's online bill-paying service to automatically take care of your monthly minimum credit card payments and other bills. Follow the steps listed in the Automatic Millionaire 2.0 diagram—and you will truly have a foolproof, no-brainer "set it and forget it" financial plan that, I promise you, will work.
David Bach is the author of Debt Free for Life: The Finish Rich Plan for Financial Freedom and founder of FinishRich.com.More Personal Finance Advice
Please note: This is general information and is not intended to be legal advice. You should consult with your own financial advisor before making any major financial decisions, including investments or changes to your portfolio, and a qualified legal professional before executing any legal documents or taking any legal action. Harpo Productions, Inc., OWN: Oprah Winfrey Network, Discovery Communications LLC and their affiliated companies and entities are not responsible for any losses, damages or claims that may result from your financial or legal decisions.
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