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13 Financial Decisions To Avoid

Posted on | September 20, 2010 | 4 Comments

There is a smörgåsbord of choices available in personal finance just as in life. Discerning between available opportunities and attempting to find the optimal financial path can be difficult and confusing, especially for those new to the game (such as recent college graduates).

Banks, Wall Street and all other financial institutions know this and will attempt to flood your perception with poor options designed to prey on the fact that you don’t have an accounting degree. I will always try to give you, the reader, the tools and information that I believe will provide the most financially-sound outcome, but the road is littered with pitfalls that can quickly drain away all of our hard work.

With that in mind, here is a list of the most common financial trap and missteps that I have encountered (in no particular order).

1. Dealing with overdraft or other cruel and unusual fees – banks should be humbled by the fact that you are essentially lending them money by opening an account with them, but they instead make the majority of their profits through predatory practices such as rearranging the order transactions are processed so that you incur the maximum possible overdraft penalty. Don’t play this game – opt out of overdraft protection, or find a new bank.



2. Keeping a negative balance on your credit card - The average credit card interest rate is 14.9%. A very optimistic annual return from the stock market is around 10%. By letting that outstanding debt sit on your card, you’re essentially giving the credit card company a better guaranteed return than they could earn investing elsewhere, and far more than you would be paying on most other types of loans. It’s ok to use your credit card to build credit, as long as you pay it off completely each month.
3. Keeping a positive balance on your credit card – Some people do this, although I can’t for the life of me figure out why. It is essentially a checking or savings account with 0% interest. Allowing your money to sit somewhere without earning interest is allowing it to lose value to inflation.
4. Stashing your money in a low-interest savings vehicle – As we discussed in Step 3: The Best Bank For Your Buck, many traditional forms of saving (regular savings/checking accounts, CDs, etc.) have a return far below average annual inflation, which means you’re slowly losing money over time. By finding a high-interest savings vehicle such as a high-yield checking account, you can overcome inflation and actually earn money over time.
5. Withdrawing from a retirement account early – This is a big one. If you pull your money out of a traditional retirement account, you will suffer an additional 10% penalty on top of incurring a taxable event on the money you have withdrawn. This is a massive amount when viewed in the long term, because you will also be losing out on the powerful compounded interest that 10% could have earned you, not to mention the amount you withdrew (and subsequently paid taxes on).There are some loopholes that will allow you to avoid that penalty and certain account types (Roths IRAs and the like) work a little differently, but you will still be robbing yourself of the interest you could have earned down the road.
6. Putting extra money towards low-interest debt – There are differing opinions on this topic. Many people suggest that you should pay off all of your debts as soon as possible. I personally prefer to invest that payoff money and let the numbers work for me, as chances are good I will end up wealthier that way.For example, my wife has several student loans at around 3% interest. Instead of paying those off ASAP, I’m allowing the money I would have put towards them to grow in my 4% APR high-yield checking account, which is giving me that 1% in net profit. Assuming the interest rate on my checking account doesn’t change, even if it takes me 30 years to pay off those loans at a normal rate, I will be wealthier than if I had paid them off immediately.Note that this is only a good idea if you have a way of generating returns that is guaranteed or very reliable, and if those returns are higher than the interest rate of your debt. Investing your extra payoff money in a volatile stock, mutual fund or ETF could actually cost you in the long run if things go against you. Paying off high-interest debt ASAP is always a good idea.
7. Putting all of your money into the same investment – The old adage of not keeping all of your eggs in one basket applies. If you put all of your money in a single stock or fund and it bottoms out, you could be in dire straits if an emergency forces you to cash out. Similarly, putting all of your money into your mortgage to pay it off quickly is a poor idea because you are robbing yourself of potential earnings in other investments. The best approach is to diversify – pay some amount towards your debts, retirement, short term and long term savings each month, and diversify within your stock market portfolio to keep it stronger and more stable (we’ll get into that more soon).



8. Home improvements to increase the resale value of your house – With the overload of shows lately on home improvement, flipping houses and similar topics, it can be easy to buy into the hype that renovating your house can earn you big bucks at closing. The truth of the matter according to Remodeling’s Cost vs Value Report is that no significant remodeling projects (with the exception of installing a new front door) will return anywhere near 100% of the cost. From floors to kitchens to bathrooms to roofing and siding, even 80% is a lot to hope for. This isn’t to say that you shouldn’t remodel your home for your own pleasure, or to help it sell faster – just don’t expect to get back anywhere close to the money you put into it.
9. Purchasing a bigger house than you can afford – This is a mistake that many people make, as often we purchase homes without understanding the full impact that our mortgage payments will have on our lives. Many experts suggest that your mortgage payments should cost less than 25%-33% of your monthly income, although many say that even 33% is too much. If too much of your paycheck goes toward the house, you are robbing yourself of money to spend on pleasure as well as the ability to save towards your future.
10. Treating your mortgage like an ATM – After the economic depression of recent years, many financial experts blamed homeowners for treating their homes and mortgages like ATMs. It is (or at least, it was) very common for a homeowner to decide that they need fast cash, so they take out second (and even third) mortgages against their homes, increasing the amount that they owe to the bank in exchange for an instant transfusion of money. When the money is gone, the homeowner can be stuck tied to a mortgage that is far in excess of the actual value of the home, especially after the housing market plummeted.
11. Eating out too often - This one is fairly subjective, but the math is easy: cooking a dinner that costs less than $5 a person is much better on your wallet than eating out for $10-$20 per person. What you’re paying for is the instant gratification of tasty eats without having to wait for the food to cook, and to not have to do that cooking yourself. This isn’t necessarily a bad thing – eating out is a big part of the social culture for college students and young professionals, and a fun way to try new foods besides. Keeping your restaurant visits to a minimum, however, and your cash flow will thank you.
12. Buying new cars - The arguments on this topic are endless. Which should you choose: new vs used? Instead of extolling the virtues of each, why not look at what the world’s millionaires do? According to The Millionaire Next Door (one of the first finance-related books I ever purchased, which helped to shape my outlook on personal finance), the trend among the wealthy overwhelmingly favors used vehicles against new ones. And we’re not talking about the short-sighted individuals who spend most of their money on costly displays to create the illusion of wealth – the book discusses the real millionaires and billionaires who own the massive companies that you and I work for.



13. Avoiding generic and off-brand items – Marketing has been very successful in past generations in creating a social stigma on “cheap” brands, and in convincing most people that the only way to be sure of getting good quality is to go with the brand they can “trust”. In today’s world of open discussion and information, more consumers are beginning to realize that in most things there is no noticeable quality difference between the name brand and the generic – only a price difference. Using food as an example: once you realize that everything in the store had to pass the same FDA regulations and so is (hopefully) equally guaranteed to be “safe”, your grocery budget can suddenly go much, much further.

These are only a handful of the many traps that can negatively impact your financial success. Once you learn to recognize the signs of a bad move looming on the horizon however, you will be much better prepared to safeguard your financial future.

Related posts:

1. Step 2 Continued: Cutting Costs (Shopping/Entertainment)
2. Step 2: Cutting Costs (Food)
3. Step 3: The Best Bank For Your Buck

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