I’ve found in interviewing millionaires that it’s not that they’ve made zero mistakes. They’ve all made mistakes of one variety or another.
But they have avoided the BIG mistakes that can really cripple anyone’s finances.
Now most of these people could withstand a larger setback or two because they generally have higher incomes (much to the chagrin of some readers).
The problems become much greater (and the margin of error much smaller) when your income is lower.
That’s why I asked my buddy, Michael Dinich from Your Money Geek, to write a post on the top money mistakes for people with modest incomes. Michael is a financial planner (I know, but he’s one of the good guys IMO) who has in worked in personal finance since 1999. He’s in a perfect position to write this as he helps families with modest incomes plan for retirement and save money in taxes.
On his site Michael uses pop culture and inspirational stories to make personal finance fun and accessible. He and I bond over Star Wars and super heroes! You might also remember him as the author of How to Make Money with a Hobby Farm: The Unsung Super Hero Of Side Hustles.
Anyway, let’s get to Michael’s list and thoughts, then we can compare it to my list of the ten worst money moves anyone can make to see where there’s overlap…
Reading articles and blog posts online you may be tempted to believe that the biggest scourge threatening your financial goals are subscription boxes, latte consumption and envy of the Joneses. Having worked within personal finance with people with modest incomes for nearly 20 years, I have learned that there are even bigger threats looking to sabotage your goals.
It is possible to build wealth with a modest income but it takes a bit more planning and time than a high-income earner. Lower earners need to be as efficient as possible, use a bit of creativity, and avoid these 10 common mistakes to become wealthy.
FYI, High-income earners make these mistakes also — and they should be avoided by all.
1. Not optimizing your tax return.
One of the biggest mistakes people with modest incomes make is not creating an income tax plan and tax budget.
The common misconception is that tax planning is only for the “wealthy”. However tax planning when you have a modest income is critical.
Even if you are in one of the lowest income tax brackets, income taxes can consume 10%, 15% or even more of your income.
For many families, income taxes are their 3rd or 4th largest household expenses. One of easiest ways to free up money is to create a tax plan.
The IRS offers several tax incentives for individuals and families with modest income, such as the Retirement Savers Credit, the Premium Tax Credit, the Child Tax Credit and the Earned Income Tax Credit. Several of these tax credits are refundable. A refundable tax credit can represent free money from the government.
Note: When you qualify for a refundable tax credit, should you manage to reduce your tax bill to zero through other means, then the government could potentially pay you extra money.
Additionally, lowering your taxable income may also help with reducing the amount of income-sensitive student loan repayments, potentially help with college financial aid for you and your dependents and may reduce the amount of self-employment taxes you may pay.
Should you qualify for several income sensitive programs, the cumulative effect could be much larger than you may think. The problem is too many people with modest incomes either put off doing tax planning or wait until tax season (Mid-January to April 15Th) to review their taxes.
Unfortunately, very little can be done after Dec. 31st to reduce taxable income. Engaging in tax planning throughout the year will help you budget for any tax planning measures that are necessary, and strategically time purchases and deductions.
Tax planning does not need to be overly complicated. You can create a tax plan using free online tools. Simply print out a list of any income sensitive tax incentives you hope to use and compare your anticipated income for the year with the requirements for the program.
[Editor’s note: This is an excellent point about working throughout the year to make the most of your tax return the next year. I trade emails with my CPA three or four times per year as we discuss various things I’m doing/considering this year that will impact my taxes next year.]
2. Paying down debt too aggressively.
We have all seen the articles online: debt is bad and loan interest destroys your financial dreams.
Paying off debt is an important goal. However individuals and families with modest incomes need to be careful not to pay off debt too aggressively. Many financial gurus such as Dave Ramsey or Suze Orman would encourage you to prioritize paying down debt before saving for retirement.
While their hearts are in the right place (they don’t want their audience to become slaves to debt), the math does not always favor aggressive debt pay down. Contributions to retirement accounts could be eligible for employer matching, retirement savers credits, and lower out of pocket health insurance costs.
Recently, I worked with a family who was paying an extra $10k a year on their mortgage and neglecting their 401k. Creating a tax plan revealed that contributing $10k to their 401k would save them over $7,500 in income taxes and health insurance costs. Now they are funding the 401k and using the $7,500 to pay down the mortgage and will be able to retire much sooner.
Paying down debt too aggressively may lead to more debt. Many savers with modest incomes get trapped into the yo-yo diet version of debt pay down. They pay debt too aggressively, saving too little to for emergencies and they are ultimately forced back into debt at the first hiccup.
Many individuals and families would be better served by paying off debt a bit slower. Try to get the lowest payments and interest rate possible. Each month allocate some money to paying down debt and some money towards building emergency funds. As the debt balance declines and your cash reserves grow, then increase the amount you pay on the debt.
3. Not engaging in estate planning.
It seems like we are constantly seeing some celebrity in the news who passed away and didn’t have proper estate planning documents. When you see a celebrity estate such as Prince or Stan Lee in the news it’s easy to question why they didn’t have proper documents.
However, everyday people with modest means have similar experiences, it’s just not deemed newsworthy. The reality is death, disability, and dementia complicate not only finances but the family dynamic.
For 20 years I have seen clients parade their adult children through the office, all of whom insist they have no interest in their parents’ finances. The overwhelming majority of people insist their estates will be handled without issues because everyone is in consensus and nothing will go wrong.
Without fail, these families end up having the biggest disasters because the combination of confidence and complacency lead to a failure to plan. Even well-intended families can be ripped apart when forced to interpret vague or non-existent instructions about how to care for a disabled loved one or distribute an estate.
Do yourself and your family a favor and reach out to a competent estate planning attorney and discuss a living trust and any ancillary documents. Trusts are typically more money than a will, however, even if you don’t anticipate probate being costly, they are often worth every penny.
4. Not engaging in asset protection.
When you visit the estate planning lawyer, you should talk with them about asset protection.
If you have a side hustle, small business, or own rentals, you should talk to a competent professional about asset protection and business structure.
Having the right business structure could protect your personal life savings from lawsuits and potential creditors of the business.
Over and above potentially shielding your personal assets, setting up proper business documents for your could have substantial financial benefits. Setting up a suitable business entity for your ventures can assist with building business credit and may even help with tax planning.
Building corporate credit for may help remove business loans from your personal credit improving your own credit score. Additionally, if your business relies heavily on credit, having established corporate credit helps ensure the company does not get shut down if key founder dies.
5. Buying too little or too much insurance.
Often people have either too much insurance or too little.
Any type of insurance, such as life insurance, disability insurance, property and casually, liability insurance is a rainy-day precaution. Effectively, it’s a waste of money until it’s needed. Yet everyone wants to view it through economic lenses.
Higher-income earners and those with more modest incomes often have many different risks, and various capacities for dealing with those risks. As such, they will need to think about insurances differently.
An event that would cause a financial inconvenience for one type of professional may be economically devastating for another. Recently, a colleague of one of my clients was vacationing with his family. He tripped and broke his leg. He is a truck driver and has been out of work for over four weeks. Since the injury wasn’t work related, he was not covered by employer-sponsored disability.
The same injury that puts a truck driver out of work and exhausts his emergency savings would have minimal impact on an IT professional, programmer, or someone who works at a desk.
It is imperative that individuals with modest incomes review what risks they may face and ensure they maintain adequate insurance.
Each year you should consider all your insurance policies, check the limits and deductibles and ensure they are within what you can handle financially. Be sure to cross-shop your insurance with various insurers to make sure you are not overpaying for coverage.
Having more insurance than you need can be costly. With that said, not having insurance when you need it can be even more devastating.
6. Taking advice from the wrong people.
Everyone has their own way of managing finances and will have an opinion on how you should manage your finances. Usually the advice is to do it just like them. Social media and the internet have afforded these opinionated people not only the ability to share these opinions with the world but also get paid to do so.
The upside is people now have access to all kinds of financial information; however, it also leads to a lot of noise. The noise makes it difficult to ascertain ulterior motives, as well as the accuracy and relevance of the opinions.
We are now living in the era of fake news, fake followings and fake experts. Recently, Drew Cloud, the media’s darling student loan expert, turned out to be a concoction of a student loan servicing company. Corporations pay “influencers” to promote their products, and there is a whole cottage industry of people who sell fake reviews and social media followings.
Consumers of financial advice need to be hyper-vigilant about who they turn to for information. Make sure anyone you are considering listening to is who they claim to be.
[Editor’s note: The best way I find to do this is to ask for references as well as do an online check of the person/company.]
7. Making decisions based on other people’s goals.
Everyone wants to know they’re making the right decisions with their finances. They often turn to friends, family, co-workers, or neighbors for advice. However, there is no one size fits all silver bullet financial plan.
Everyone has different financial goals and resources. Using someone else’s financial plan could be the lead to financial ruin. A plan needs to be customized to consider your health, your goals, and any risks that you face.
Your neighbor with no kids and a sizable pension may be able to be much more nonchalant about market risks than someone who has a family to support and is responsible for producing their own retirement income.
8. Failure to develop a backup plan.
No matter how well you plan, life has a way of tossing us curve balls.
A high-income earner with a high savings rate, who has been saving for a few years, likely has the safety net of being able to take a lower paying job if the economy cools. Modest income workers tend to be more at risk of changes in the labor market.
Business may cut back on hours or overtime, or even lay off people in response to a recession. Those with more modest incomes may not have the same ability to discount labor to remain in the workforce and be successful.
The best course of action is to develop a backup plan. Keep your resume updated and work on professional development. Investing in yourself is one of the best investments you can make. It increases your income in good times and helps provide security in bad times.
The best time to pursue any certifications or additional training you may need to reenter the labor market is before you are forced to.
[Editor’s note: I call these having a margin of safety and career insurance.]
9. Allowing family to derail your plans.
It is possible to save for retirement on modest incomes and even retire young enough to enjoy retirement. However, the family can be an impediment to reaching your financial goals.
The best financial help you can provide your loved ones is to encourage them to have a healthy relationship with money and develop a financial disaster preparedness plan.
During the financial crisis we learned it wasn’t the market downturn that caused so much devastation. Instead, it was the collateral damage.
The stock market was in freefall, banks were cutting lines of credit or refusing to lend, and businesses were cutting back on spending. The labor market was poor, and many adult children or grandchildren were turning to their parents and grandparents for financial support.
Encouraging your family to develop a financial disaster preparedness plan can help eliminate the need to liquidate your investment at an inopportune time.
Teach your children about money and saving, encourage adult children to maintain an emergency fund, save, and to get proper legal documents including prenuptial or post-nuptial documents.
10. Being overconfident.
A little bit of worrying is actually good for your finances. When you are overconfident, you often ignore precautions.
Preparing for every situation is impossible. However, you can and should make the most of what could go wrong. The best planning starts with asking what could go wrong with the plan and developing safety nets to ensure you are protected.
Ask yourself, what would happen if you were injured and couldn’t work? How would death or disability impact the household income? What would happen if hours were cut or you were laid off? If you had to enter the labor market, what would you need? Are your certifications current, and reflect what employers today would be looking for?
Should the market decline, how it would affect your short-term goals? How would it change your long-term goals?
Having answers to what could go wrong is not about working until age 70, as Suze Orman may suggest. Instead, being prepared allows you to retire sooner and provides you with sleep insurance that you know if something goes wrong you will have a plan to deal with it.
Making Modest Money Work
It is possible to pursue your financial goals on modest income. However, there is less margin for error.
Making modest money work requires planning ahead for contingencies, focusing on opportunities to free up extra money, and making sure you’re not led astray by the new hottest financial pied piper.
Focus on your goals and what you need to do to achieve them, and don’t worry if the path to your financial goals is different than others.
P.S. For those who prefer a video version of this post, see the ESI Money YouTube channel.
The Physician Philosopher says
I think number 2 is massive. When people done reduce their tax burden or leave money their employer may match/contribute to their 401k, it blows my mind. But I see it happen all of the time, even with docs who stand to lose 30-40k with that mistake.
The same could be said of the savers credit and contributions to an IRA when in a lower tax bracket. That’s potentially money left on the table.
Great overview, Michael. Really good stuff.
Dave @ Accidental FIRE says
Taking advice from the wrong people is one I see with my friends. Everyone knows someone at work who has a “hot stock tip”…..
I really enjoyed this article as it focuses on me and my family as a “modest income earner”. I am currently a stay at home mom living in the UK and can easily double our income by going back to work and living in America. However, I am torn between being there for my family as well as exploring Europe vs going back to the states in order to double our income which would bring us to a 6 figure income.
Really enjoyed this post being I’m one of the readers with a normal salary. Believe I had done a good job with my planning but agree there is a lot of noise out there regarding how to handle finances. Realized even making a 1-5% mistake would be huge in the long run for my retirement planning. Found a quality Financial Advisor (Fee only and has nothing to sell me ) who helped me improve my plan by small changes here and there with their main focus on tax planning. They are also helping change my thinking from small goals to the big picture goal. Turns out I was making small mistakes that would add up significantly by the time I retire not to mention I would have been paying more in taxes.
Great job Michael on a much needed topic. With less money there is way less margin for error and you need to be focused with the money you have to deploy it in the best way.
I always suggest retirement contributions at least to the level of the match of an employer in a 401k for example. That is the best return of money out there and can often be a 1:1 return up to a certain level. You are leaving free money on the table if you don’t take advantage of this and your employer has counted this in their benefits package to you so if you don’t take advantage of it you are getting a smaller salary than you would have without this benefit as that salary was factored in by the employer.
Proper insurance is a must as well as, unlike higher income individuals, you can’t just cash flow a problem away. If something bad happens, having insurance and an emergency fund can be the difference between going into a lot of debt or not.
Avoiding probate will allow your heirs to inherit the maximum amount they can on your passing (and not the lawyers/judge). A trust is the best vehicle to avoid probate and should be something anyone considers. It’s more expensive than a will but it also saves a lot more money in the long run.
As someone on a low ish income and having worked with people on very low incomes I recognise so many of these. Especially lack of insurance. We’ve had a few fLash floods here in the UK and I despair every time I hear someone interviewed saying they are not insured. You can’t afford to NOT be insured. You CAN afford not to have a takeaway/night out in order to pay a small house insurance premium.
Paying debt down without having an emergency fund is classic. Debt can often happen because of an emergency but lessons are not learned and so the cycle can repeat.
Andrew @ Wealthy Nickel says
100% agree on #2. Paying down debt as quickly as possible is preached by all of the personal finance “gurus”. But there is a difference between mortgage debt and credit card debt.
And as you mentioned, if you are using all available income to pay down debt, you are missing out on huge tax advantages and employer matches in retirement accounts.
The suggestion about paying down debt too quickly when there are other things on the table sticks with me. The only reason I’m in a reasonable position as I look towards retirement is that I was fully committed to putting some money away to receive the company match despite having debt (to include credit card debt at the time). Perhaps not the purest financially savvy move, but you have to develop that habit of putting money towards your future and not touching it for what really amounts to convenience. I’ve seen too many others tap their retirement savings for any number of reasons that IF they had actually followed through on their future would have made financial sense, but the reality is that they never actually caught back up, and never will. To many times we bet on our future selves being radically different from our current selves and then are surprised when we don’t change.
#6 hit home for me. That was my parents. I describe it in my post on the negative impact on inheritance. My father would ask anyone for financial advise, a friend in his optimist club, the guy in line in back of him at the bank, anyone but his family.
He has 14 children, and at least five of them including me know about finances, but he wouldn’t come to us
Great article for many people without a plan or direction, however I’m not exactly on the same page with you when it comes to recommendation #2.
I’m a Dave Ramsey follower and true believer in his guidance since it is working for me. It took me awhile to change my mentality but my family is so happy that I did. I come to realize that by investing while still having non-mortgage debt is dumb. By doing so, I was only thinking about my “future self” while my “current self” was struggling to get by. If I had an emergency and I needed the money I had previously dumped into retirement, then the penalties would eat away any benefit of the investment. A temporary stop of retirement savings is not going to impact you as much as slowly being bled dry financially month after month by debt.
By getting focused and attacking my debt with “gazelle intensity” (as Dave says), I was able to pay off all of my non-mortgage debt in less than 6 months. Now, I have much more breathing room in my monthly budget to fully fund my retirement savings and I have a very healthy emergency fund thus keeping “Murphy” out of my life.
I’m a decent earner…right around $100K each year depending on how much I work my “side hustles”. But by becoming focused and fed up with debt this year, I’ll finish around $150K. If I keep this up, I’ll be completely debt free including my mortgage in less than 6 years. I will be turning 46 and completely debt free! What if I don’t keep this up and it takes me twice as long? So what! I’ll be 52 and debt free with another 15 years left to pound all my income into retirement. At that point, I would be working part-time or full time because I want to…not because I have no other choice.
“The borrower is slave to the lender” -Proverbs 22:7…everyone needs to do themselves a favor and stop focusing on the future self if you are not healthy financially now. If you take care of your current self and stop the financial bleeding now, then your future self will be just fine. My only regret is that I didn’t start the Dave Ramsey “Baby Steps” plan sooner.
I couldn’t agree with you more here. Also a Dave Ramsey fan and I hate debt with all my breath and paid off all my non-mortgage debt aggressively too. Now, I’m trying to pay off the 15-year mortgage in 5 years (2 more years to go) and I’m aggressive as hell even though it’s only 3% APR.
I started listening to Mr. Ramsey earlier this year and was pleasantly surprised that the philosophy my wife and I developed over time was already out there with his baby steps program.
I listen to his podcasts even though I no longer have debt to pay off. The trick is to sacrifice a bit at first so that later you can live like no one else.
I have always thought (as does Mr. Ramsey) that when you focus on something, you get it done quickly and well. His recommendation to temporarily stop investing and focusing on paying down debt is based on this principle. If you don’t focus, there is great risk of not getting out of debt. By the way, he does not advocate not investing when you have a mortgage, though he does recommend finding a way to pay it off within ten years.
Most of us do not have the time, fortitude, patience, knowledge to figure out a multi-level investment strategy that will ensure we make more money from investing and paying minimum payments on debt than just taking the simple approach on focusing on getting debt out of the way and then focusing on building wealth.
I took this pay off debt approach and it has worked very well for me. An added bonus is that if something happens and my income goes down, there is zero impact on my life as I have no debt commitments to stress about.
I highly recommended to people of all income levels that want to retire early.
Reluctant Frugalist says
This list is great! Estate planning, tax optimization, paying debt in an appropriate manner-these can protect your earnings or break the bank!
Debt Free Dr. says
I agree with #6. it’s like taking weight loss advice from a guy over 400 lbs eating a bucket of fried chicken with a Pall Mall hanging out the corner of his mouth!
What is a modest income? What range?
Millionaire Mob says
#2 all the way! If you make a modest income, why would you allocate capital to something sub-optimal. Continue to allocate capital in the highest producing areas to increase income and net worth. This is ‘harvesting stage’ if you can get this done, paying down debt down the road will be very easy.