More often than not, money mistakes are committed by people who are what we could define as smart. There are plenty of doctors, lawyers, engineers and even finance professionals who make dumb decisions. I can fairly say that I am less smart than all of the above, but in some aspects still do a better job of managing my money than many of them.
The reason is that personal finance is not always a matter of being a genius. Other factors like behavior, culture and upbringing come into play. Most of the principles are very simple and straightforward. The challenge is to bring ourselves to apply them.
With that said, here are some money mistakes smart people make.
1) Not taking Advantage of an employer match
Many companies offer 401(k) plans for their employees, and they often times include a certain amount of free money called a match.
Unfortunately, a lot of employees do not take advantage of the full match, as illustrated in this report by Financial Engines. Over a forty year career, such negligence can easily add up to hundreds of thousands left on the table.
If you genuinely can’t afford to save for retirement at the time, it’s okay. Just work on increasing your income and improving your spending habits if possible. By the same token, if you make good money but spend it all every month, just know that you’re wasting money twice: once at the register when you decide to buy things with money you should be saving, and once more by not having contributed enough to your 401(k) to get the free money.
2) Taking out a 401(k) loan
One of my smartest co-workers whom I look up to for a lot of things made the mistake of taking out a 401(k) loan. I really believe no one should do it unless it really is the only option and it’s an emergency. For example, using retirement accounts for a down payment on a home or a wedding is just a no-no. In my co-worker’s case, he was using the cash to start an online retail business.
I can think of many reasons why to stay away from these types of loans. The biggest one is the loss of compounding power. 401(k) loans are technically not loans, but can can be better described as early withdrawals that have to be returned in the future. In other words, the amount “borrowed” is no longer in the market and therefore can’t earn any dividends or capital gains.
In addition, one of the main advantages of a 401(k) is that it’s tax deferred. On the other hand, a 401(k) loan repayment isn’t, so you basically lose the tax efficiency once you touch the account.
Another major issue is in that in the case of a job loss, the full balance becomes due. If it’s not paid off in two months, the government treats it like a distribution. This means that unless you’re at least 59 1/2 years old, taxes become applicable, along with a 10% early withdrawal penalty.
Bottom line, it’s a bad deal in most cases despite the fact that it may seem like the easiest thing to do.
3) Not having the proper amount of insurance
Many people are constantly at the mercy of a bad situation ruining their financial life. A serious car wreck, a medical scare and in some regions a natural disaster are all things that happen pretty often. Protecting ourselves and our assets is imperative to a less stressful and more importantly less risky life.
The topic of insurance needs to be looked at in two ways. First, we have to determine what products we need (health, disability, renters, car, etc..). Then, the next step is to evaluate how much of each product we need to buy. Everybody’s situation is different. Some of the variables that may affect this decision are salary, age and health. In addition, the options also differ depending on the area.
Regardless, taking time to plan for the unpredictable pays dividends both financially and mentally.
4) Not tracking their net worth
If you’re like most people, you hope that one day you have the freedom to do whatever you want. That doesn’t necessarily mean retiring or playing golf everyday, but certainly the option to do so.
Above all, reaching that level depends on how much money you have. This is why knowing your net worth is critical. I enjoy checking mine because it encourages me to keep making progress and at the same time gives me an idea of what I need to do to stay on track with my goals.
5) Market timing
My boss, who I know is very smart, told me she got so scared during the recession that she moved her entire portfolio to bonds. Since then, the stock market has more than recovered, and she missed out on a lot of the returns. Mind you she’s in her early forties, so she didn’t even need to access her portfolio anytime soon.
This Marketwatch study illustrates the potentially devastating effects of market timing. I have never experienced a market downturn, but I will make sure to read articles like this if I ever think about doing something stupid.
6) Not checking bank account activity for unexplained charges
When it comes to our finances, automation is awesome. For example, instead of paying every single bill manually, we can now save time and brainpower for other things that are less mundane.
Nonetheless, having computers do our work for us can cause complacency that affects our wallet. Just last week, I saw a $100 charge on my checking account for an online textbook seller I haven’t used since I graduated college two years ago.
To avoid getting ripped off or falling victim to system errors, it’s always good to check bank statements from time to time.
7) Failing to negotiate a salary or a raise
This is one I have been guilty of. Even though it may seem awkward to bargain your salary, it is very important to do so.
The best way to get a fair outcome is to know your value and accomplishments and lay out realistic expectations. No one will give you a raise because you’re struggling to pay your bills.
Surprisingly, when it comes to salary, a couple thousand can make a huge difference. That’s because raises and even bonuses are often given as a percentage of your current salary. As a result, the higher the starting point, the better. Just like stock market returns, raises have a compound effect.
The table below shows the long term differences between starting salaries of $55,000, $60,000 and $65,000 over a forty year span. I use a 3% annual raise since average raises in the US typically hover around 3-4%.
|Salary after 10 years||$73,915.40||$80,634.98||$87,354.56|
|Salary after 20 years||$99,336.12||108,366.67||$117,397.23|
|Salary after 40 years||$179,412.08||195,722.27||212,032.46|
8) Borrowing for college when graduating debt free is an option
According to Business Insider, tuition and fees at private universities averaged roughly $8000 more than at public schools for the 2011-2012 academic year. Over the course of four years, that totals to more than $30,000. On the other hand, undergraduate student debt for the class of 2016 stands at $37,172. I rest my case.
I attended a fairly prestigious private university (no bragging intended, I sound like a tool here). When it was time for me to find a job, I don’t remember being asked much about it. The conversation about academics usually lasted a couple minutes at most. I also got multiple rejections for positions I wasn’t qualified for, which shows that school prestige is not as big a deal as we make it to be.
Unless you’re looking for something really rare and specific or the public colleges in your home state are all terrible, I think you should consider attending college at home, in a state school. School name won’t make you any smarter.
9) Not using credit cards
A lot of smart people are (rightfully so) very debt averse and therefore avoid using credit cards altogether. Although such a choice comes from a good place, it is not always a very smart one.
Credit cards do not necessarily mean debt. As I put it in last week’s post, I treat my credit cards like debit cards. In other words, I only use them for purchases that are in my budget and I make sure the balance is paid off every month.
By staying away from credit cards, we miss out on one of the best ways to build a high credit score which is critical if we plan on taking a mortgage for a home. Credit cards may also offer perks like cash and travel rewards, theft protection and rental car insurance among others.
10) Casually borrowing money
Last but not least, way too many smart, educated people with high potential for financial success hurt themselves by having a casual attitude towards borrowing. What I mean is that they treat it as if it’s something normal like walking to the park or buying groceries. A quick look at the average car note in America says it all.
Some even go further and go into debt with a “plan” to invest their capital and make up for the interest rate costs. In many cases, such a strategy is risky and represents just an excuse to buy more than we can afford.
Based on all these everyday mistakes, it’s safe to say that in the personal finance world, IQ is not the most important factor. A lot of money mistakes happen to the smartest people.
Sometimes being smart exposes us even more, as you can see with the college tuition example. To avoid falling into these common traps, it’s important to approach everything with a humble mindset.
It’s okay to be clueless about something and ask questions. Ignoring our weaknesses and spending our life winging it just because that’s what most people seem to be doing is the kind of behavior we should stay away from.
Sidenote: Check out my feature on Canadian Budget Binder’s Making A Difference series here.