When it comes down to it success in managing personal finances is pretty simple: spend less than you earn over a long period of time and invest the difference. Said another way, they boil down to E-S-I. 🙂 If this is the heart of your financial plan, it’s likely that you’ll be prosperous.
That said, there is one other thing you’ll need to do – you must avoid the financial pitfalls that can significantly derail your finances.
I call these the worst money moves anyone can make. I’m listing them below in countdown fashion along with some suggestions for avoiding them.
Here are the top ten IMO:
10. Not having an emergency fund.
An emergency fund is your first line of defense against unexpected financial problems.
And believe me, unexpected financial problems happen rather regularly. Washing machines break, cars need repairs, kids need braces, and so on. It’s a fact of life.
If you don’t have an emergency fund, you will likely have to borrow money when an emergency pops up. And as we’ll see soon, borrowing is an even worse money mistake.
So how much should you save in your emergency fund? A good rule-of-thumb is to have six months’ of living expenses saved up. In addition, be sure to keep your emergency fund in a safe place — you certainly want it to be there when you need it. Don’t worry about earning a ton on it, no one ever became rich by making money off their emergency fund, just make sure it’s safe and accessible.
9. Neglecting to make a will.
Money magazine reports that 57% of Americans don’t have a will, including 69% of parents with kids under 18.
Without a will, guess who decides what happens with your finances and your kids? The state! Do you really want to let your state decide these issues for you?
To avoid this bad money move, you need a will and the other documents that account for good estate planning – probably at least Patient Advocate and Medical Records Release documents for most people. And be sure to update them regularly as your life situation changes.
8. Not having enough insurance.
I think of insurance as a very big emergency fund that supplements your cash emergency fund. It covers the things you couldn’t save up to cover in advance, helping to replace/protect the largest assets you have – your career, your home, your investments – if you experience a major accident, death, or injury.
I’d suggest you have adequate coverage in the following insurance categories:
- Homeowner or Renter’s
- Long-term Disability
- Long-Term Care (this one isn’t mandatory yet IMO, but I’m still considering it)
One more bit of advice: do not go overboard and become over-insured. No one needs to win the lottery when misfortune occurs (for example, your family most likely does not need a $10 million life insurance policy on you. If you have one and you don’t make $1 million a year or so, you’re probably spending too much on life insurance.)
But you do want to be sure you have enough insurance to replace your assets in times of trouble or loss. Take a balanced view and only pay for what you truly need.
7. Marrying the wrong person.
There are actually two major financial mistakes related to marriage: marrying a spendthrift and getting divorced.
Couples where both spouses know and apply financial basics do much better than ones where one or both spouses have bad financial habits. The Millionaire Next Door says:
What if your household generates even a moderately high income and both you and your spouse are frugal? You have the foundation for becoming wealthy and maintaining your wealth. On the other hand, it is very difficult for a married couple to accumulate wealth if one is a spendthrift. A household divided in its financial orientation is unlikely to accumulate significant wealth.
In addition, a divorce is a major hit to any couple’s finances. According to the Journal of Sociology, those who divorced saw their wealth shrink by 77 percent – a larger decline than would occur by simply splitting a couple’s assets in half.
My advice is to discuss finances prior to marriage to make sure you’re financially compatible. Once married, stay married. And make financial decisions as a couple.
6. Not saving.
As I noted earlier, the formula for financial prosperity is pretty simple:
- Spend less than you earn
- Do this for a long time
If you do these two things, you will be wealthy. Why? Because you’re saving money.
On the other hand, if you’re not saving, you’re not making progress financially. And the longer you wait to save, the harder it will be to catch up later.
The proper financial move is to save a portion of every paycheck you receive. A good rule-of-thumb is to start out by saving at least 10% of your income, and from there the amount should increase over time.
And some may ask just what you are saving for? Any major expense you know you’ll have in the future: a house, retirement, cars, college costs for kids, etc.
5. Buying too much house.
I’ve talked a bit about how to buy a house and there’s really not much else to say other than this guideline from the book Stop Acting Rich: …And Start Living Like A Real Millionaire:
If you’re not yet wealthy but want to be someday, never purchase a home that requires a mortgage that is more than twice your household’s annual realized income.
4. Waiting to invest
There are three factors that determine how well your investments (savings) perform:
- The amount that’s invested (how much is invested)
- The return rate on your investments
- The length of time they are invested
Most of what we see in the press deals with getting the best return on your money. But actually, the factor that most influences the value of your investments is the time you have it invested.
And the longer you wait to save and invest, the more you’re costing yourself.
Here’s an example that illustrates the power of saving early:
Smart Saver starts saving $3,000 every year, starting at age 20. After 10 years, her $30,000 total contributions are worth $47,000 (at an annual growth rate of 8%). At age 30, Smart Saver stops saving and makes no further contributions. She just lets the money grow at an 8% annual rate of return for the next 30 years, until age 60. At age 60, the $47,000 will have grown to $472,000.
Her sister, Late Saver, waits until age 30 before she starts saving $3,000 a year. Unlike her Smart Saver sister who stopped saving after 10 years, she doesn’t stop saving. She saves every year for 30 years, from ages 30 until she is 60. At age 60, her account is worth only $367,000.
Now I’ll add a couple extra points to this example to show how Smart Saver could really have made it big in saving and investing for retirement:
- If Smart Saver would have kept saving $3,000 her whole life, she would have ended with almost $835,000.
- And if that $3,000 would have been $5,000, she would have ended with $1.4 million.
So the solution for this money problem is to:
- Save early
- Save often
- Save more (as a percentage of your income) as time goes by
3. Being deep in debt.
AARP notes that, “Over a lifetime, the average American will now pay over $600,000 in interest.”
$600k? Ouch! This is a pretty big example of the fact that debt is very costly — it can rob you of hundreds of thousands of dollars.
The solution to this mistake is simple:
- If you’re in debt, start taking my steps for how to get out of debt.
- If you’re not in debt, don’t get into debt.
2. Not working to maximize your career.
Your career is your most important financial asset. This is because the average American can reasonably expect to earn in the neighborhood of $2 million during his lifetime. But if that person works hard and grows his income at 8% per year, he could have more than $3 million more than that. If he doesn’t, his $2 million can dry up to a bit over $1 million (or even less). So not working to make the most of your income can cost you millions of dollars.
To avoid this bad money mistake, simply develop and execute a plan to make the most of your career.
And let me add a couple other mistakes you do not want to make because they can derail your career and your income as well:
- Do not quit your job without another job lined up. Yes, it may be stressful to work where you do, but not having enough to eat is much more stressful.
- You must take care of yourself physically. Eat well, get plenty of rest, exercise, and enjoy life. Your career and its earning potential are dependent on you being able to work.
If your outflow exceeds your income, then your upkeep will be your downfall.
The first step to gaining wealth is spending less than you earn — it’s vital to making any financial progress. So when you over-spend, you’re doing the most damage possible to your finances.
Here’s what Stop Acting Rich says about the issue:
Most people will never earn $10 million in their lifetime, let alone in any single year. In fact, most households (97%) are unlikely to ever earn even $200,000 or more annually. So what if you are unlikely to become rich by generating an extraordinarily high realized income? The only way you will become rich is by being like those millionaires at the other end of the continuum: by living well below your means, by planning, saving, and investing.
There are two types of over-spending that can ruin your finances:
- Over-spending on the little things – the small amounts that seep out of your pockets here and there and eventually become large.
- Over-spending on the big things – homes, cars, boats, cottages, and so on.
The top complaint I hear from people who don’t have balanced budgets is, “I don’t make enough money.”
I’m telling you that in the vast majority of cases (probably 95% or more), it’s not the amount these people make – but the amount that they spend that’s the problem. (In some cases it’s true that people simply don’t make enough money to save, invest, etc. As such, they need to concentrate on increasing their income as much as they need to control over-spending.)
My wife and I once counseled a guy who made $130,000 a year. This was back in the early ‘90’s, so $130,000 was worth something (it’s still pretty good today.) When I saw his income, I thought “this will be a piece of cake” to make a balanced budget. But once we got through the mortgage on the mansion he owned, the four luxury cars he leased for himself, his wife, and his kids, and the amounts they spent on clothes and vacations – they had spent it all and then some.
And people who make much, much more can spend it all as well. Here’s a quick review of several wealthy people who spent more than they made – despite the fact that they made a bundle.
- Mike Tyson — The famous boxer reportedly earned $300 million in his career, but it wasn’t enough to support a lavish lifestyle. He filed for bankruptcy in 2003, owing $27 million.
- MC Hammer – Despite a former $33 million income, he filed for bankruptcy in 1996.
- Scottie Pippen – The former Chicago Bulls star lost $120 million in career earnings due to poor financial planning and bad business ideas.
- Evander Holyfield – Four-time boxing champ reportedly made over $250 million in cash during his boxing career, but despite this he is now flat broke.
Some others who made big money and spent it all and then some include: John Daly, Nicolas Cage, Bernie Kosar, Gary Coleman, Kim Basinger, Don Johnson, Michael Vick, Andy Gibb, Isaac Hayes, Lenny Dykstra, Latrell Sprewell, Mick Fleetwood, and Marvin Gaye.
This is why over-spending is the #1 money mistake – because no matter what your income is, if you spend it all plus some, you’re going backwards financially and you’re losing ground.
What to do to combat this: develop a budget and live on it.
So, that’s my list of the worst money mistakes anyone could make. What do you think of it? Did I miss anything? Is the order wrong? Feel free to add your thoughts in the comments below.
P.S. For those who prefer a video version of this post, see the ESI Money YouTube channel.
I think you pretty much nailed it, although I would move buying too much house much closer to the top. Anecdotally, I have seen a combo of 1 and 5: Friends are spending too much, but primarily because they bought WAY too much house and aren’t compromising in any other way. I live in a city where you can buy a huge amount of space in the burbs for wicked cheap, but people don’t want to live that far… so they refuse to downsize and buy its equivalent in the city. I try not to be judgmental, but these are friends that complain about how broke they are and I just want to gesture at their beautiful but expensive house / condo that they are likely not making extra payments on, and maybe never will.
Buying a home increases the difficulty of almost all of these items so it seems critical to not buy too much house… you need a serious emergency fund, will that takes a home into account, more insurance, the stress on a marriage of buying a house (giant investment) as a couple, decreases investing and saving and increasing debt due to payments and house expenses…
Also I wonder how much the mortgage interest tax deduction fools people… I have heard it is part of what’s to blame for people buying too much house, but I’m curious if people just see it as a bonus or really think they are somehow saving money by paying $10,000 in interest to save $2500 in taxes. I don’t know if you plan on doing a post on that ESI, but I think it is a great topic that people don’t entirely understand.
At one point do you think it is safe to assume you are “self-insured” for purposes of life and disability insurance? I understand the need for things like umbrella, property, auto and other types of asset protection insurance, but life, disability and long-term care I view differently. I get that there are a lot of factors like children, spouse, etc., but wonder where the tipping point is, generally speaking.
Also, with regard to buying too much house, at what point level of net worth would you consider it okay to spend more than 2X annual income. For example, is it still prudent to spend 4X annual income on a mortgage, as long as the value of the house represents less than 25% of net worth?
For life and disability insurance, I think it’s safe once you get to the point where your financials responsibilities would be handled by your assets even if you had no income (and potentially extra healthcare costs). The specific answer will be different for each person/family. We still have life and disability insurance but probably don’t need them. The former is cheap and part of a 20-year policy that expires in 7 years or so. The latter I’ll keep as long as I’m working.
As for the house, I don’t have a rule of thumb on the number of times annual income. What we did was look at our overall budget, decide what we felt comfortable paying, and bought a place based on that (this was for the last time we had a long-term mortgage.) Generally, I’d shoot to be entirely debt free (including mortgage) by 55 or so, but that’s just me (and I’m known to be conservative.)
I agree hole heartly with the list.
One thing that I think that is a hard concept for anyone to understand is setting a goal you want to acheive in the future. An example would be my car is paid off now I should save it for the next car. I want to retire at 59 1/2 but how do I get there?
Some how I think they are linked in that people don’t think of where the want to be in the future and make these above decisions without fore thought.
its a good list, based on it however i have violated #7 & 5. fortunatley my spouse is now a reformed spendthrift with a healthy net worth- but he once argued with a financial planner that a certain amount of debt was good. Fortunately, as i said, he is reformed and now quite frugal. for those who may be curious it was black and red that did it. …. and competition. i put our finances into a monthly spread sheet, cash flow, net worth-his and mine. he didnt like the disparity and began to change.
The rule of thumb about housing is important however; our housing was 2x our joint income. however current health of a spouse is no guarantee of future health. fortunately since we have no other debt our family can live on one salary-but on one salary we violate rule #5.
This story also touches on #8-insurance. seriously consider stand alone disability-in general the risk of disability due to injury or disease is greater than any other risk we face, yet the vast majority of us only have disability through our employers. Many if not most of us work/live in a state with ‘At Will’ employment laws. meaning our employers can terminate our employment for no reason. ESI you experienced this. if you become ill, diabetes, heart disease etc, even though you may still be holding your own, your employer can terminate your employment and with it goes your disability which may be needed in the not too distant future. This is what happened to to my dear spouse he was well liked and a top producer but they didnt like the time he spent out of the office in doctor appointments.
one must be prepared for this to occur without warning and the CDC reports that 47% of our population have at least one chronic disease, and 20% have 3 or more.
You are so correct about disability insurance. There’s a much greater chance people will need it than need life insurance — and yet the former is relatively ignored.
I got my disability policy years ago and have kept it no matter who my employer was.
This is an interesting comment. I have also heard this many times. However it caused me to stop and think because I just recently new a 37 year old who died unexpectedly. In fact in the past 20 years I can think of 5-10 people who have died too young with families to support and the first thing I always think of is I bet they didn’t have nearly enough if any life insurance. And usually you find out they did not. However I cannot think of a single person I know who got seriously injured, could no longer work and for whom I wound up thinking, I bet they don’t have enough disability insurance.
This is obviously just anecdotal, but it would be interesting to know what other’s experiences are. I am starting to doubt the disability versus life insurance statement and would like to see some numbers to support it that don’t include people who meet the govt definition of disabled because I have seen plenty of them come through and apply for housing with me and if they are disabled I am a zebra.
I’ve been in corporate America for 25 years and have seen way more disability claims than life insurance claims.
Now if we’re talking LEGITIMATE claims, then they are probably even.
Short term or long term? I have heard of plenty of short term claims but those aren’t what I think of as a true need for disability insurance. I can’t say I have heard of any real permanent long term claims though and those are the only kind that compare to the catastrophic effects of not having life insurance. If the claims about disability being used more than life insurance include all the short term claims and non-permanent long term claims that might last 6 months to a year then I would say the statement is misleading. It’s like saying you are more likely to need auto insurance than life insurance. Certainly you are, but if you crashed your car with no insurance and lost 20K, it’s not the same as having no ability to generate income for the next 30 years.
Mostly ST, but I haven’t really kept track of how many of those morph into LT.
Dr.J @ MedSchool Financial says
Nice list ESI, and would agree on the overspending. Even when people get a raise or promotion, they lifestyle expenses always seem to be in a race to catch up to their income. Its key to live below your means at every level.
DIY Money Guy says
Just saw you over on Financial Samurai and stopped in to check your site. Looking good. I like your money mistakes list. I guess there a so many money mistakes that we are all making and that people can relate to that is makes for a popular topic. I, incidentally, recently wrote an article on the top 10 money mistakes as well: http://www.diymoneyguy.com/10-money-mistakes-part-1/
Looks like we agree on quite a bit and there is a fair amount of overlap in our top 10 lists!
Good luck with the blog!
Thanks! Same to you — liked your list and your site!
great summary- thanks!!!
i could charge myself as guilty on 3 counts:
10. not guilty
7. not guilty
6. not guilty
5. not guilty
4. not guilty
3. not guilty
1. not guilty
Great checklist to keep me on track! I think I have been avoiding all of those so far but it’s definitively something to think about in our day-to-day. Thanks
Trevor McClintock says
Great list – have definitely been guilty of a few of these in the past. Never knew that some of those famous names filed for bankruptcy, staggering!
I think that you need to qualify your terms and concepts a bit better and give people a bit more hope if they start on their pathway to wealth later in their lives.
1) Number One $ Mistake Should be – not earning enough money, cultivating enough assets, and not knowing how to position yourself for maximum gain. If you spend money on assets, leverage earnings and credit to acquire more assets, that will lead to far greater security than simply straightline saving by working a job. Culturally not all people (note gender, race, demographics) have an equal playing field as it pertains to be hired and being paid at the best salaries. Therefore it is better to invoke a strategy to make your money work for you and offset these limitations with a power network and well devised strategy to be on a higher playing field. Yes it is important to reserve (10% for tithing, 10% for savings, and 10% for investments) money for life’s emergencies. However, the most important thing is you have to make enough money first. If one is working a minimum wage job as his or her only source of income – your suggestions will not work. Having 2-3 low earning jobs simultaneously will not work either. Your example is for middle class and above incomes only. Not all are so privileged.
2) I agree with Robert Kiyosaki’s comment that savers are losers because saving prevents one’s money from increasing at the highest levels. Saving is a short term, front end strategy while asset building is the long term, overall strategy. You can plan your way to the highest quality of life by both spending and saving with the right plan. You save for liquidity and spend for assets. Your assets should pay for your highest quality lifestyle and allow you to gain access to the greatest tax benefits. Unfortunately, when one is simply an employee, he or she leaves a lot of money on the table. Also the time he or she is working to make someone else rich, he or she could be taking a higher cut of profit by being a direct provider of a product or service.
3) Your Job is a Tool not Your Total Source of Income – To me the only purpose of having employment is for seed money to invest and acquire assets or to gain a mature skill set to accumulate your own wealth. Working a job as one’s only source of income may be the most limiting pathway to income accumulation. There are better benefits to owning a business or working as an employee part time for full time pay and then leveraging a portion of that to build assets for financial freedom. You can even do consulting on the weekends or off work hours. Also people should seek that which has at least a commission and bonus on top of their base income if they are an employee.
4) Financial Literacy – Most schools will not teach the fundamentals on how to own a business, acquire assets, or what is that best field of study to simultaneously gain both income and flexibility (consider technology coding schools that are a 6 month fast track to a career starting out at $60K). Nor are there any real self empowerment skills that are taught on what it takes to generate and maintain wealth. In addition, on how to develop problem solving skills to obtain a college education, own a car, own a home or purchase other liabilities debt free using assets. T. Harv Ecker talks about one’s financial blueprint being established in the subconscious based upon the environment the person has been exposed to while growing up. Therefore, to combat student loan debt, unemployment/underemployment and other liabilities that are necessary for living, it is going to take a new way of thinking and targeted strategy.
5) Social Network (How to make belonging to a Sorority/Fraternity/Club Count) – I am not referring to the media channels as much as I am referring to positioning one’s self while in high school and college. Each organization is designed for you to acquire a skillset (such as Habitat for Humanity can teach you how to build and fix property that can be used to flip real estate or gain rental properties), to always have someone to go to for mentorship, job referrals and leads, to partner with friends and colleagues while in college for entrepreneurship (to do real estate or network marketing due to the greatest concentration of talent and large masses of people), and to help grow one’s influence. You can also barter skills and leverage money with a buddy to insulate yourself from the lack of options in the marketplace and put yourself in a position of power by not waiting for the yes from an interview. Consider Mark Zuckerberg, Bill Gates, and many others who leveraged their position more outside the classroom than inside.
6) Faith To Step Outside the Box – Minimizing Risk Through Solid Education. It is so important to seek out other information than what is taught in school and learn higher principles such as investing in Sponsored Retirement Plans maximize your retirement earnings, tax lien and deed certificates, and every other wealth accumulation strategy. Having the proper education and exercising high leverage strategies will have a rippling effect in families. The more you know the further you go.
7) Tax Strategies – By putting one’self in the position of being and Investor or business owner one can legitimately acquire assets and write off business expenses that would otherwise not be taken as an employee. Also it is important to learn to strategies how to qualify business expenses in advance.
8) Debt – The power of debt can work for you rather than against you simply by positioning yourself as the one who is the collector through real estate, recovery services of judgments, tax liens and deeds, becoming an angel investor or VC, paying for training and education through credit or loans that is then turned into an asset as an income producing opportunity. Also consider the car sharing Uber/Lyft phenomenon of using a vehicle to make money and recover the depreciation on the taxes even if you have to lease or have the car financed. Another strategy is learning to defer paying off one’s debt in full for a short term to use the resources to grow wealth through an income opportunity.
9) Insurance and Financial – it is also important to not have too much insurance and know the difference between whole and term. Another important issue is for retirement planning and financial advisor fees to not pay too much in the adminstrative costs rather than paying into the plan.
10) To diversify your platform of earnings: stocks, real estate, SRPs, tax liens and deeds, and self directed IRA’s.
I think a lot of this is informative even though much of it goes over my head. I will say though I have been working for 30 years and have missed opportunities because I have a pre-existing condition so I would not take jobs without health insurance. But I do know not everyone has the same opportunity. If you know someone at a company and I don’t and we are competing for the same job you will get it. I just want to say you can’t save money if you earn 2000 a month, rent is 1400 and meds are 800. Very difficult to get above this.
Jeff Weeks says
Just stumbled on your blog, this is a great article. Couple of other mistakes I’ve seen:
1. Being too aggressive/conservative with investments. Putting a new IRA into one high flying stock only to see it drop significantly or just leaving retirement money in cash can both take a big bite out of the power of compounding.
2. Using tobacco. A user can easily blow $1MM+ in their lifetime on the products and associated healthcare costs.
Keep up the good work!
Amy Anderson says
How does all of this work if you are divorced, single mom of twin 15-yo, and my career is teaching high school math? Teaching has little pay increase each year ($250-500/year). Insurance has gone up around $200/month for the last 4 years. Basically, my take home pay has decreased. I will have a pension comparable to what I make now in 7 years.
My house payment is financed at 2.5% interest rate, and it is 23% of my yearly income.
I have my will & living will, long-term care insurance, auto insurance and health insurance ($523/month). I have 4 months salary saved for emergencies, which I’ve had to use from an accident.
How do I save mote when I’m living paycheck to paycheck?
This is my rant, my plea, my begging:
I’m a teacher and love seeing my students learn. All of those millionaires you spoke about made it because teachers taught them, so they could go further in their education, where other teachers (AKA Professors) taught them. Yet, teaching is not a respected profession in general. I wish the millionaires you speak of would realize they are in a job with the potential for so much growth because of the teaches that inspired them at some point in their education. Start looking at what is happening in education for teachers and current students. Take a stand with the state and federal government to help the people who helped you!