Written by Thomas M. Geier, CPA, CFP ®, PFS
We are all creatures of habit. Habits are the regular tendencies we have, whether good or bad, that can be difficult to break or even just modify. While all our financial situations are different, we all have the ability to improve upon them. The first step is acknowledging there is an issue. Do you ever wonder why you can’t seem to get ahead? Have you told yourself, “I’m going to do better this month,” only to find you haven’t moved the needle one bit? Perhaps one or more of these bad money habits could be the culprit.
Putting Off Saving for Retirement
Many individuals put saving for retirement on the back burner, especially younger workers. The longer you put off saving, the more it will set you back in the long run. Participate in your employer’s 401(k) program. Most employers will even match your contribution at a certain percentage to encourage participation. If your company doesn’t offer a 401(k), consider opening and contributing to a traditional or Roth IRA. To promote saving, have a portion of your paycheck transferred over to your IRA monthly on an automatic basis.
Let’s say you start saving at age 25 and contribute $200 per month, and then assume you earn a 7% annual rate of return on your investments. Assuming you continue saving at this rate, you’ll have around $497,000 by the time you turn 65. But if you were to start saving at age 26 and all other factors remained the same, your total savings by age 65 would lower to $462,000. The $2,400 you saved between age 25 and 26 could have turned into about $35,000 by the time you retired, as a result of compound interest.
To learn more about the benefits of compounding and saving for retirement, visit our recent blog “Power of Automatic Contributions.”
Withdrawing from Your Retirement Accounts
Some individuals dip into their retirement accounts when they want to pay off debt, buy a new car, or can’t obtain a loan due to poor credit. No matter the reason, it is important to understand that these retirement accounts were intended to be used for retirement.
- Most withdrawals taken from a 401(k) prior to age 59 ½, will be taxed as ordinary income and suffer a 10% penalty fee.
- Most traditional IRA withdrawals made before age 59 ½ incur taxes and a 10% penalty as well, but with an IRA you can withdraw the money early without the 10% penalty if you use the money to pay for qualified education expenses, medical expenses above 10% of your gross income, or you use up to $10,000 of the money for a qualified first home purchase.
- A Roth IRA differs from the 401(k) and traditional IRA in that your investments did not grow tax-deferred and provided you are age 59 ½ and have held the Roth for at least five years, the distributions you take will be tax-free. There is a penalty of 10% for early distributions with a Roth IRA, but only on investment earnings. You can withdraw your original contributions tax and penalty free before age 59 ½. Roth IRA withdrawals are considered to be taken from contributions first.
So, tapping into your retirement accounts could be setting you up to pay some hefty fees. Not to mention, you could be putting your financial future at risk by preventing your retirement savings from growing over time.
Dipping Into Your Savings Account or Emergency Fund Account
Part of the reason many people dip into their savings or emergency fund accounts is that they are so accessible. Keep these accounts separate. Don’t house this money in the same checking account you pay your bills from. Consider a high-interest savings account or money market account so you can earn a higher interest rate than standard savings accounts. Keep in mind the purpose behind why you even opened the account. If you are pulling money from out of your emergency account to pay for the new iPhone, where will you get the money if an actual emergency pops up?
Only Paying the Minimum on Credit Card Balances
Typically, you are only required to make a minimum payment each month, usually 1 – 3% of your balance. Paying the minimum is tempting, especially when times are tough. However, paying minimal amounts now will cause you to pay more later.
Say you owe $750, and you decide to stop using the card while making minimum payments until the card is paid off. Your minimum monthly payment would be $30, and it would take you 54 months to repay the balance. Your total payments would be $1,739, and $988 of that amount would be interest.
If you carry a credit card balance, not only will you be in debt longer, but the amount of interest you will pay will add up to be quite large, thanks to enormous interest rates.
Living Paycheck to Paycheck
Many people live beyond their means causing them to live paycheck to paycheck. The better practice to employ is living below your means enabling you to set aside money every month to allocate to areas such as your emergency fund, retirement savings, college savings, etc.
Unfortunately, many people treat credit cards as cash. With interest rates that are usually 20% or higher, if you aren’t paying them off every month, you are paying much more in interest and your debt is morphing into a mountain that will feel as if it is impossible to climb. Some use them for those must-have shoes they saw, others for that Starbucks drink to get them through the day, and others rely on them when an emergency strikes such as a hot water heater going up or an unexpected medical expense. Keep in mind, the higher your credit card balance, the higher your bill, and the longer it will take you to pay it off. This may make it difficult for you to make payments towards your other bills such as your mortgage, utilities, and car payment. This may also translate into late payments and a hit to your credit score if you’re not careful.
Not Investing Your Money
Even if you only have a little to put aside each month, it worth it to invest and capture the benefit of compound interest. Compounding makes a sum grow at a faster rate than simple interest because in addition to earning returns on the money you invest, you also earn returns on those returns over time. An example from Burton Malkiel, the author of A Random Walk Down Wall Street, shows the power of compound interest:
“William starts saving $4,000 a year when he is 20 and stops after 20 years, after having saved $80,000. His brother, James, starts saving $4,000 at 40, and does so for 25 years, for a total of $100,000 saved.
They earn 6% on their savings.
At age 65, William will have $850,136 in his account, while James will have only $219,242. Despite having saved less, William’s nest egg will be almost four times greater because of compounding.”
This is a very powerful example!
Apps such as Acorn make it very simple for individuals to invest minimal amounts. Speaking with an investment advisor can be helpful too. They will ask about your objectives/goals, determine what your propensity for risk is, and then help you design an investment portfolio that aligns with both.
Turning Your Cheek to Unnecessary Fees/Costs
Using an ATM that doesn’t work with your banking institution (doesn’t have your bank’s logo on it), will yield unnecessary fees of on average $3 – $4 dollars. You can usually locate an ATM that will not cost you extra by looking on your bank’s website. Review your monthly expenses and look for things that you may no longer use any more such as gym memberships, subscriptions, streaming services, styling services, or free trials that you may have signed up for and forgot to cancel.
Not Creating a Budget/Plan
Know where your money goes. Track your spending. Understand how much is coming in and how much is going out on a monthly basis. Be proactive and search for ways to cut down in areas that are not supporting mandatory expenses. Strive to have the majority of your income applied to support your “needs” not your “wants,” or “sounds good in the moment” situations. Be purposeful, not spontaneous and rash. Programs like Mint.com help individuals track their spending.
Create a plan that aligns with your budget. Outline your top goals for the year. Tackle any high-interest credit card debt and create a plan to pay it off over time. There are different approaches to this. Ordering your debt so that the one with the highest interest is your number one priority and then the next highest and so on. Pay the most toward the highest interest debt, while making minimum payments on the rest until the debt with the highest interest rate has been paid off. Then move down the line until they have all been paid off. Others prefer the “snowball method,” whereby you rank your debt according to size and attack the smallest first. This method provides momentum. As soon as you’ve paid off one debt, you apply those newly available funds toward the next debt on the list. No matter which method you choose, the most important factor is that you have created a plan to successfully pay down your debt.
Sources: CNBC/ Marketwatch/ The Balance/ Burton Malkiel
© Geier Asset Management, Inc. March 2019. Thomas M. Geier, CPA, CFP ®, PFA is a Vice President of Geier Asset Management, Inc., a Registered Investment Advisor. The articles & opinions expressed in this material were gathered from a variety of sources, but are reviewed by Geier Asset Management, Inc. prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of March 2019 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual circumstances. In all cases, please contact your investment professional before making any investment choices. Geier Asset Management, Inc. is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.