9 Commonly Made Mistakes with Money
People commonly make mistakes with money – here are some of the most common
- Receiving a Hefty Tax Refund Every Year
It is a sign that too much tax is being withheld from your paychecks. If it is the only way that you can save, it certainly beats not actually doing (provided that you actually save the money or use it to reduce debt).
The problem here is that this is not the most effective approach to saving. You are not only losing your ability to earn anything on the interest-free loan to the government, but you also don’t have access to the money in case of an emergency.
If you typically receive hefty refunds, you can use an IRS calculator to show you how to fill out your form W-4 the right way. Just ensure that you set aside part of the money from your paycheck to cater for emergencies. Forced saving is better than not saving at all.
- Having Just a Rough Idea in Your Mind of How You Spend Your Money
It is often said that it is impossible to manage what is not measured. If you were to ask most people how much money they spend, they are usually able to list a couple of bills and various other expenses off the top of their head.
However, once they start combing through their credit card bills and bank records, they are almost always surprised to discover exactly where their money goes. It is due to this reason that you should do the same thing.
One option would be going through not less than three months’ worth of previous statements recording your expenses on an Excel spreadsheet by category. You can alternatively use Yodlee MoneyCenter or Mint.com to track your expenditure for free.
Both of these resources have Android and Apple apps designed to help you manage your money while on the move. Neither approach is necessarily better so you should simply select the one that you are more likely to use.
- Forgetting the Non-Monthly Expenses
Vacations and holidays are some of the largest sources of credit card debt. You can easily convert them into monthly expenses by dividing the amount that you usually spend every year by 12.
You can then have the monthly amounts set aside every month automatically so that funds will always be available when you need them. While you won’t earn too much at the current interest rates, it is still better than paying interest on credit card debt.
- Spending More Than Necessary
Once you understand the exact amount you are spending and where your money is actually going, you should find ways to reduce some of the expenses. You should remember that plenty of people who live on less than you do irrespective of how much you earn. Some people actually save as much as 75 percent of their income and retire within as little as 5 years.
Do you have memberships or subscriptions that you hardly ever use? Do you do comparison shopping for things such as groceries, cell phone plans, mortgages, and insurance policies? Sites like Money Expert can make this easier. Are the purchases you make status symbols or are they things you actually need? Are there lower cost ways to achieve the same results such as bringing your own coffee and lunch instead of having to visit Starbucks or eating out each day? You might be surprised by how little changes really add up over time.
- Living from One Paycheck to the Next
Living from paycheck to paycheck is one of the biggest mistakes, especially with the high unemployment rate and people taking much longer to find jobs. It is why so many financial experts recommend having between 8 and 12 months of necessary living expenses as opposed to the traditional 3 to 6. If this sounds daunting, start with a goal you can easily achiever and build from there.
A Roth IRA is one of the best places to start. You can withdraw what you contribute to a Roth IRA tax and penalty free at any time for any reason (if you withdraw your earnings before age 59 ½, they are subject to taxes and probably even a 10 % penalty) and what you don’t withdraw becomes tax free after age 59 ½ (if the account has been open for not less than 5 years). This means that you are able to save for retirement and build an emergency fund tax free at the same time.
The important thing is to ensure that the money is invested somewhere accessible and safe like a money market fund or account until you have sufficient emergency savings elsewhere. At this juncture, you are free to invest your Roth IRA in more aggressive investment options for your retirement. (If your earnings are too high for you to contribute to an IRA, contribute to a non-deductible IRA instead then convert it to Roth. Just remember that you have to pay tax on the conversion if you have any pre-tax IRAs).
- Paying a Bit Extra on Credit Card Debt
It is definitely better than failing to make extra payments or not actually paying the bill in full. However, you can pay off the debt quicker if you put all the additional money towards the debt that has the highest interest rate and make minimum payments on the rest. Once you pay off the balance, you can put those payments towards the remaining card with the highest rate until you are free from debt.
- Assuming that Borrowing from Home Equity is never a Good Idea
Like most myths, there is some truth to this. You will be putting your home on the line after all, so this is not advisable if you will be unable to make the payments. Having said that, refinancing high interest credit card debt using a line of credit or home equity loan makes sense because your interest rate could be much lower and credit deductible
- Assuming that You Must Never Borrow From Your Retirement Plan
Like the previous one, there is some truth to this. People usually assume that retirement plan loans are free because the interest simply goes back to the account. However, costs are there in the form of lost earning in your account and the risk that the outstanding balance after 60 days of leaving your job may be considered as a taxable distribution and thus subject to an early withdrawal penalty of 10%.
It is due to these reasons that you should not take retirement plan loans for frivolous reasons. If you are looking to use one to pay off high interest debt, ensure that it is part of a long-term plan for staying free of debt. The last thing you want to do it run up your credit balance after you have depleted your retirement savings.
- Saving What Remains at the End of the Month
If you just save whatever is left at the end of the month, you should not be surprised when you are left with nothing to save. A better approach would be to set aside savings automatically before you have the chance to actually spend it.
The easiest way to do this is ensuring that your employer’s retirement plan because it is deducted from your paycheck. The same applies for dependent care and medical expenses if you qualify for HAS or FSA. You can even have the money transferred automatically from your checking account to your savings account as well as an IRA.