Making the wrong financial decision can hinder your goals and cause significant economic hardships. Understanding how to avoid them is vital, but knowing how to recover from a poor decision is just as important. That’s because life is not perfect. Sometimes, we have to make decisions that are not fiscally sound due to limited options. So, to help your bottom line thrive, here are four common financial mistakes to avoid and how to recover from the occasional setbacks.
We’re diving right in…
#1 Not tracking your spending or debt levels
Visiting Wawa or buying lunch daily may not seem like a big deal, but every little bit adds up. Spending $50 per week on coffee and lunch would cost you $2,600 per year, which could go toward debt payments, increased savings, or more towards retirement!
When we do a financial plan, the first task is determining your spending per month or year. We can’t work on saving, paying down debt, or working toward any other financial goals if we don’t know how much you spend.
The second part of spending is understanding how to use debt. Debt is a part of life. There is good debt and bad debt. I wouldn’t say I like calling debt good. Let’s call it what it is: reasonable debt and dangerous debt—borrowing to buy a home – reasonable. College loans – reasonable. Using credit cards that you won’t be able to pay off immediately is dangerous.
Use credit cards only if they will be paid in full every month, without fail. When not paid off, the interest increases the purchase costs and often results in spending more than you earn, ruining your budget. Not to mention the running the risk of falling further behind.
Recovery: The best advice is to plan your spending and stick to it! Assigning clear spending limits for each category is an excellent way to control your spending, which hopefully leaves you with more cash to save and invest.
It’s not that hard to create a spending plan. There are three steps:
- Determine your monthly/annual net income.
- List your non-discretionary expenses – utilities, insurance, taxes, etc.
- List your discretionary expenses – the unnecessary items you spend money on.
- Viola, you’ll have your information on how much extra cash you have or don’t have at the end of the month.
There are plenty of apps, or you can use paper and pencil. Also, don’t try to live like a penny-pincher. It almost guarantees failure. Create a fun spending category for the occasional treat. Allowing yourself a few extras makes it easier to stick to your plan.
If money is tight, or you want to save more to achieve a financial goal, getting a grasp on your spending is the best way to turn your financial ship around.
Finally, what happens if you’re drowning in debt? First, don’t panic. Second, incorporate a debt reduction plan into the spending plan.
- Please stop using the cards until they are paid off.
- Set aside a monthly amount in your budget to go toward the balances, even if that means cutting back somewhere else.
There are a few schools of thought about which debt you should attack first. The one with the highest interest rate is always the financially best move. However, for psychological reasons, paying off the smallest debt is often an excellent idea to notch a win under your belt. Whatever works for you, as long as your debt is being reduced, is the one you should go with.
#2 Disregarding an emergency fund
Unexpected expenses happen. Loss of employment, medical bills, or car repairs will kill your budget and create the possibility of increasing debt. Unless, of course, you have an appropriately funded emergency fund. That is how to keep your budget on track.
This probably should be the number one mistake. Too many people rely on cash flow and credit cards to cover emergencies. That’s playing with fire, and you’ll get burned.
It’s best to keep three to six months’ worth of expenses in a savings or money market account you can access quickly. It’s better than credit cards, and you can take your time to replenish the account.
Recovery: If you don’t have an emergency fund, return to mistake number one and complete your budget analysis. Then you’ll know how much you need to cover three to six months of expenses. Create an emergency savings category in your budget and slowly build via automatic deposits into savings. It may take time, but that’s ok.
One other note of caution: many people invest extra cash instead of setting aside a specific amount in a savings account. Emergency savings is something you don’t want to risk. Your goal should be to fund your emergency savings. Once achieved, then you should direct extra cash into an investment account.
#3 Ignoring retirement
You will retire someday, whether you want to or not. Most people want to, and comfortably so. That means contributing enough to your retirement accounts is necessary and not an option. Not many workers have pensions any longer, and Social Security alone will not pay the retirement bills.
A 401(k)/403(b) will be your single most significant retirement wealth-building option, providing the ability to sock away a nice amount. In addition, most employer-sponsored retirement plans come with employer-matching contributions.
At a minimum, you must contribute enough to receive the whole match. But let’s be honest, that doesn’t cut it for building a healthy retirement nest egg. Although employer matches vary depending on your employer, they are rarely more than 6%. You need to save 10% to 20% of your income.
What about if you are self-employed or your employer doesn’t have a retirement plan? You have to be more creative and disciplined when saving for retirement, but there are options. You can use a traditional or Roth IRA or a plain old investment account. For the self-employed, you can use a SEP, SIMPLE, or Solo 401k.
Recovery: Using time as your ally, you must begin saving ASAP and slowly increasing your savings over time. Those small sums can add up over time, even if you can only set aside a small amount each month.
We recommend starting with the minimum, up to the company match. Then, if you receive a raise, increase your retirement contribution by one percent. You are keeping some for yourself and ramping up your retirement savings over time. You will hardly realize it. That same strategy applies if you’re self-employed or don’t have a retirement plan through your employer.
#4: Not having enough insurance coverage
Sometimes, it can be hard to fully grasp the importance of buying insurance until you find yourself in an emergency that could potentially wipe out everything.
Think of insurance as the catastrophic emergency fund that supplements your regular emergency fund. It is another safety net that protects your critical assets, such as your home, car, and, most importantly lives of your loved ones.
Having the proper level and type of coverage for all of your loss risks is often overlooked. Nope, it never feels good to pay those premiums. Hopefully, you’ll never need to use them, but if you do, you’ll be thankful you have appropriate protections.
Appropriate is the key word. Neither too much nor too little coverage is vital. You need the right coverage at the right time.
Recovery: Analyze your risks, needs, and life situation. Do this every few years or when you have a life-changing event such as a marriage, birth, etc. For example, your insurance needs in your early twenties when you’re single and living at home will be pretty different than when you’re married with children and have a mortgage.
Also, don’t forget about the risk benefits available through your employer. Since they are part of a group policy in most cases, they are a cost-effective way to supplement your risk coverage. The downside is that they are generally not portable; if you leave your job, the benefit does not follow you.
Your decisions will have a substantial effect on your financial future. While these financial mistakes can create financial difficulty, success is about limiting mistakes and building on good choices to create a solid financial foundation. Mistakes happen, and as long as you dedicate yourself to promptly implementing the steps to recover, growth and success are possible. Make planning your finances a priority.
If you need assistance getting your finances in order, contact Great Oak Wealth to help you get on track.