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Seven Financial NoNos

March 30, 2017
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Whether it’s retirement planning, saving for a house, or even paying for school, there are plenty of positive steps you can take to achieve your financial goals. Very rarely, however, people ask me about the other side of the equation: what are things a person shouldn’t do if they want to build a solid foundation? What practices should I avoid? What toy should I leave on the shelf. Unfortunately, the paths you shouldn’t take can end up being what derails your efforts. So today, I would like to walk through seven common mistakes we see from clients, old and young, in the hopes that you can dodge these potholes in your personal life.

1. Ignoring your credit score 

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It’s highly likely you’ll need some type of financing in your life. Whether buying a house or getting a car loan, even a private student loan, your credit score matters. Things that are common for young professionals, such as moving every couple of years, and older professionals such as helping kids with school costs or buying your dream home, may mean that more companies are checking your credit than usual. Monitoring your score on a regular basis allows you to catch any unwarranted inquiries that can drag down your score, and also to see what can be done to make it increase. Credit monitoring sites will send you updates when your score rises and falls, and keep your credit report clean as you add to your portfolio.

2. Leaving money on the table: it’s true, your emergency fund should get a lot of your attention. Building up a cash nest egg can be helpful in many ways, and it’s always good to have cash you can get to quickly. In order to be balanced, however, you need to maximize the amounts going towards your retirement. Because you earn compound interest when you invest (interest growing on top of previously earned interest), the more years you have in the market, the more powerful the compounding becomes. Additionally, when you don’t contribute, you may be letting your company keep money in their pocket they were willing to give you. If your company matches your retirement contributions, let’s say 4%, they will only deposit their 4% after you’ve done so yourself. By contributing at least what your employer matches, you’re using free money to double up on the funds being saved for your future.

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3.Cashing out your retirement accounts: now that you’ve saved some money in your 401(k) or IRA, keep it there! It’s easy to miss the forest for the trees as an investor. If you leave a job after a short period and have $5,000 in your retirement plan , it’s tempting to just cash it out and pocket the money. By doing so, you not only take away the power of compound interest, but you also subject yourself to unnecessary fees and taxes (10% penalty for withdrawing prior to age 59 ½, and ordinary income taxes).If you’re saving in a balanced fashion, any immediate cashflow needs should be met with savings outside of retirements. Using retirement accounts to fund expenditures, or even 401(k) loans for things like the downpayment of home, are options that should only be taken if there is no other alternative.

4. Paying for “want-tos” with your emergency fund: when you’re reasoning with yourself, it can be easy to convince yourself that you have to make every wedding, college graduation, and high school/college reunion you’re invited to. Or why a new *insert Amazon wish list item here* is a sound purchase. While you should make sure you treat yourself from time to time, that treat shouldn’t be the result of you dipping into your savings. Not starting an emergency fund, or dipping into savings to pay for things that you want, but don’t need, is an easy way to cut your financial legs out from under you. If you have a trip coming up or something you would like to buy, set a goal to put aside money each month separate from what goes into savings. If you can’t put aside the necessary amount, you probably can’t afford what you’re looking to buy. But if you can, you’ll feel free to spend that money knowing that you’re still taking care of business.

5.Settling for a credit card:

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There’s a reason credit cards flood 18 year olds with offers and advertisements. The quicker you get used to buying things with money you don’t have, the harder it is to break the habit. Credit card rates are among the highest financing rates around  because they’re unsecured, meaning you’re borrowing money without providing any collateral. If you’ve been led astray, get back to the practice of only paying for things that you actually have the money to purchase. Limit yourself to one credit card for emergencies, and work as hard as possible to stay within 30% of your credit limit (once you borrow more, your credit score starts to decrease). If you haven’t needed a credit card before but are concerned it might be a need in the future, consider a secured credit card or a charge card. With a secured credit card, you put down a cash deposit for the card, and you are limited to borrowing either all or a percentage of what you deposited. Since you've had to provide the deposit in cash, secured cards can keep you from borrowing money you can't afford to pay back. Charge cards are like credit cards, but unlike some credit cards who only ask you to pay the minimum each month, charge cards encourage you to pay off your balance in full at the end of the billing cycle.

6.Believing cars equal success

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Mainstream culture can lead us to believe that the things we see advertisements for (cars, TVs, etc.) are the things that mean you’re successful. In actuality, investing money in things like cars is one of the worst steps you can take as a young investor. While you should treat yourself within reason, the majority of your funds should be invested in things that appreciate in value, not things that decrease in value. So when it comes to things that you have to purchase, ask yourself this question: does this raise or lower my net worth (what you have minus what you owe)? If you still need but it lowers your net worth, make sure that you limit your exposure. If you need a car, don’t get a Lexus when a Toyota would work, or a 2015 model instead of a 2009. If you don’t need it and it’s a treat to yourself, make sure that you can either put aside money to pay for it outright, or that your monthly payments can be made without affecting your savings goals.

7.Thinking you’re immortal

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The younger you are, the likelier you are to believe in your own immortality, or at the very least, that you’ll have a long and healthy career in the field of your choice. The older you are, the more likely you are to think that money for things such as life and disability insurance is better spent elsewhere. I wish both trains of thought were correct, because I don’t enjoy paying for insurance any more than the next person. But there’s one thing I know: nobody makes it out of this life alive, which means if you have someone you love, life insurance may be a need in some form. And unfortunately, everyone doesn’t make it through a long and healthy career either. So disability insurance can help protect your income in the event of your illness or disability. Is it the sexiest part of your financial plan? No. But it is the glue that can keep the whole project from falling apart in the event of an emergency.