Much is written on the “biggest financial mistakes” that people make with helpful tips for avoiding them. We’re used to seeing many common examples of how people can get themselves in trouble through certain activities, such as charging up credit cards, making minimum interest payments, buying cars new rather than used, not shopping auto insurance plans, etc. The list of common mistakes people make in their finances can fill a book, yet they are all rooted in the failure to adhere to the most basic rules of finance. If you follow these rules, you will be less likely to make the common mistakes. If you fail to follow the rules you will be committing one of the seven deadly sins of personal finance and the mistakes will likely follow.
Not Setting Achievable Financial Goals
“If you don’t know where you’re going any road will get you there” – a quote oft attributed to life sage, Yogi Berra, best describes those who wander aimlessly through life without goals. In finances, as in life in general, nothing positive is achieved without deliberate action linked to specific goals, or a lot of luck. Whether it is to get out of debt, establish a 12 month emergency fund, or retire on time, it is not likely to happen without clear, definable and achievable goals backed by specific action steps to achieve them. People who can’t get out of debt, or who can’t retire on time don’t plan to fail, they just fail to plan.
Not Saving for Emergencies
More than half of working adults are just one paycheck away from financial disaster. The hard lesson of the last few years is that no one is invulnerable in times of economic distress. Nearly one in three adults will be unable to continue to work due to an unexpected illness of accident at some point in their working life. Life happens. Water heaters break, cars stop running, people lose jobs. One of the biggest reasons people spiral into debt is due to unexpected expenses. At a minimum, you should have a cash or savings emergency fund enough to cover 3-6 months of living expenses.
Failure to Diversify
We all know about the importance of diversification when investing in stocks or mutual funds. Spreading your money among different types of stocks from different sectors assures that all of your money is not exposed to any single risk. The same rules of diversification apply to wherever you invest or save your money. For example, people who have all of their money sitting in interest bearing savings are vulnerable to the single risk of inflation which, over time, can be as devastating as a stock market decline. The big difference in this example is that the stock market always comes back, but you can never get back the purchasing power lost to inflation.
Not Monitoring (Managing) Your Credit
At various points over your lifetime, credit will play an important role in your finances – to buy a car, a house, get a job, lower insurance rates, finance a business, etc. No matter your current credit standing, your financial life will be shaped by your credit score which can change on a daily basis. 10 points in either direction can translate into hundreds or thousands of dollars in savings or costs. If you’re building your credit, certain activities or changes to your debt can swing your score 50 points in either direction. Most score reductions are due to reporting errors which can occur frequently. Perhaps the biggest reason to monitor your credit is the growing threat of identity theft and fraud. Credit monitoring needs to be an integral part of your financial management.
Focusing on Lifestyle over Quality of Life
People who tend to focus on life style rather than quality of life are more likely to get into financial trouble. What’s the difference? Your life style is choice-driven often influenced by external factors and personal perceptions of what might make you happy. Quality of life is a state of being, a subjective measure of happiness and how much enjoyment you derive from your life. While life style choices can lead to a better quality of life, they can also lead to its decline. It’s life style choices that tend to lead to impulse buys, buying more house or car than you can afford, consumption over savings. Focusing on quality of life means optimizing the opportunities and benefits your life affords you that can lead to a feeling of well-being, much of which doesn’t cost a thing.
Remaining Financially Illiterate
Unquestionably, we live in complicated financial times. No matter how simple we think our financial lives are, there are dozens of different forces impinging on us that can impact how our future unfolds – an ever-expanding tax code, constantly changing economic conditions, government policy decisions, new banking and credit rules, a growing number of choices in financial products. Then there is the basic understanding of how money, debt and savings works – the time value of money, compounding interest, the cost of borrowed money. And, most people aren’t aware of all of the different types of risk that can wreak havoc on savings and investments – market risk, inflation risk, interest risk, credit risk, and longevity risk. The biggest mistake many people make is to rely upon other people’s knowledge when making financial decisions.
Paying Retail Prices
This is really just a euphemism for the larger financial tenet of “shopping smart.” People who pay attention to what they pay for goods and services not only save hundreds of dollars a month, they are also more likely to be in control of their finances. And, in a time of online shopping, box warehouses, digital coupons, generic brands, EBay, and Craigslist, there is almost no reason to pay full retail price for anything. We are witnessing the dawn of “frugality’” not to be confused with being cheap. It’s about making smart decisions about each dollar you spend and that requires a knowledge and understanding of your options. Why pay $4 for a box of brand-named cereal when you buy it generically for $2.50. You do that 50 times over the course of year and you’ll have an extra $100 in your savings. That new leather purse you’ve been eyeing for $300 can probably be purchased on EBay for $100. You get the picture.