Are You Sabotaging Your Savings?
Three years before reaching retirement age, a friend of mine quit his (full-pension, government) job, and soon began subtracting money from his 401(k) in order to pay off his mortgage. This was obviously a huge lapse in financial judgment, but it got me thinking about subtler money mistakes that we’re all prone to — errors you might even think are the right move, until they turn around and sabotage your budget.
“Many of these costs recur year after year, which really adds up — and often the savings from correcting such mistakes is hundreds, if not thousands, of dollars annually,” says Lee Gimpel, director of development for LifeWise Strategies, which produces Money Habitudes and The Good Credit Game. “But the good news about righting these financial wrongs is that many can be fixed in a day, sometimes even with a single call.” Here are 11 easy-to-miss budget busters and how to fix them, fast.
Having a High Balance in Your Checking Account
Instead: Invest it.
You know how good it feels to take cash out of the ATM and see a hefty sum remaining post-withdrawal? Unfortunately, it’s also a sign that your money isn’t being put to good use. “Many of us suffer from financial inertia — we have our paychecks automatically deposited into a checking account and then the money sits idle, not earning any interest,” says Gimpel. “But you should only keep enough in your checking account to pay your bills.” Put the rest into a money market, CD, IRA or work with a financial planner. Many employers will deposit your paycheck into multiple accounts, so think about allocating a portion of each payment to go directly into an investment account.
Cutting Back on Daily Small Indulgences
Instead: Tackle larger, less visible expenses.
While we’re all for sticking to a budget, don’t hinge cost-cutting on minor expenses. “Instead, look at your car payments, health insurance costs or monthly bills,” urges Gimpel. “A change there can be much more broad-reaching than skipping coffee.”
Go through your credit card statements and tax returns with an eye turned toward the heftier charges. Since new plans and deals are introduced constantly, spending an hour shopping around for a cheaper health care plan or cell phone provider can pay off big-time…oh, and you’ll still get to enjoy your daily iced latte.
Paying Down the Credit Card With the Biggest Balance First
Instead: Focus on the card with the highest interest rate (if there’s a big difference in rates).
Even though a big balance appears more damaging on the surface, high interest rates can ultimately pack a bigger wallop to your paycheck. Let’s say you owe $5,000 on one card with an 18 percent interest rate and $10,000 on a second card at 13 percent. “Even though that $10,000 looks ominous, the card that’s charging 18 percent is the real crisis,” says Ric Edelman, chairman and CEO of Edelman Financial Services and author of “The Truth About Retirement Plans and IRAs.”
To break it down in simple terms, you’re being charged $18 for every $100 owed on the high-interest card, versus $13 per $100 on the other. Once you’ve met the minimum payment on both cards (if you fail to pay the minimum, you’ll be slapped with fees, your credit report will take a serious hit and your interest rate will be jacked up), concentrate on cancelling out debt on the highest interest rate first.
Having Multiple 401(k)s
Instead: Consolidate them into a single IRA.
There’s a ton to think about when you start a new job, from familiarizing yourself with the workload to navigating a whole new set of office politics. And the last thing on your mind is probably your 401(k). “These days, people will hold between 10 to 15 jobs in their lifetime — which also means they may contribute to between 10 and 15 different 401(k)s,” says Edelman.
One byproduct of all that job-hopping? “The average American worker has five dormant accounts open,” he says. Some of those accounts have been forgotten about; others abandoned after the employee moved and neglected to forward their address to a former employer.
Kudos to you for investing in the first place, but don’t let ancient 401(k)s slip your mind. If you’ve lost track of any of them, reach out to your previous company’s HR department to request the info. Then, roll the 401(k)s all into a single IRA or add them to your current 401(k). If you have three different active accounts, then you’re also paying three sets of accounting fees.
Buying Extended Warranties
Instead: Skip it.
Many salespeople stress the benefits of purchasing an extended warranty, but it turns out, doing so is one of the best ways to waste money. A recent survey by Consumer Reports found that 55 percent of car owners who purchased an extended warranty hadn’t used it, even though the median price people paid was about $1,200. Plus, those who did take advantage of the warranty spent more on the coverage than they would have to take care of the repairs out-of-pocket. Also keep in mind that since warranties have a lot of fine print, there’s a good chance whatever problem you’ve encountered won’t be covered.
Consumer Reports also discovered that warranties often increased the price of a product by at least one-third, and that retailers keep upwards of 50 percent of what they charge for the plans. Translation: It’s definitely in their interest to sell you on it. “Remember that many products come with a manufacturer’s warranty anyway,” says Gimpel. “In addition, your credit card protects certain purchases.” And if a product does break down and you don’t have a warranty? Before paying for repairs, it’s worth it to reach out to the manufacturer. Many times, they’ll replace or fix damaged goods for free.
Being Too Frugal
Instead: Reevaluate whether your attempts to save money could actually be costing you.
Ironically, it’s not always smart to cut back. “If you’re the kind of person who’d buy a cheap used car with a lot of miles, consider the potential cost of it breaking down, needing to be towed and repaired, and you missing work as a result,” says Gimpel. “Sometimes it’s better not to be so dedicated to saving money [in the short term].”
Do you often buy the cheapest option available, only to later find that it doesn’t last? You’d be better off paying a bit more upfront for a higher-quality product. Have you ever driven across town just to save a few cents on gas? It’s time to give your frugal living decisions a reality check.
Improving Your Credit Score From “Good” to “Excellent” Right Before Making a Big Purchase
Instead: Get your score up months in advance.
If you have good credit and you’re planning to take out a car or home loan, it’s well worth the wait and effort to bump your credit rating up into the excellent range a few months pre-purchase. For instance, on a $200,000 mortgage, someone with a score of 750 might pay $30 more each month versus someone with a 760. While it may not seem like a big deal, it takes a toll: $360 a year and $7,200 during the course of a 20-year mortgage.
“That’s a ton of money, especially considering that you can pretty easily raise your credit score by 10 points before locking down the mortgage rate,” says Gimpel. If you fall just outside the “excellent” credit category, it should only take a few months to correct, so don’t pass up that low-hanging fruit.
And if your credit isn’t so great? “Granted, boosting your score all the way from poor to excellent isn’t a quick fix,” says Gimpel. “When people finally see how ignoring their score has real, everyday costs, it’s usually a head-smacking moment.” It’s still a smart idea to improve your rating before investing in a big-budget item, as long as you can hold off for a while — it’ll take years to hike up your score by 100 or 200 points.
Investing Your Extra Income in a College Fund
Instead: Put it towards your 401(k) or IRA.
It seems counterintuitive, but contributing to your kid’s education isn’t necessarily a smart move if you’re not already maxing out your retirement accounts. “Parents often sacrifice their financial future for the sake of their children,” says Peter Dunn, “Pete the Planner,” radio host, personal finance expert, and author of “Mock Retirement.” “The reality is, a college degree can be financed while a retirement can’t.”
You can take out loans to help put your kids through school, but if you’re short on cash when you retire, your options are pretty limited. While no one wants to saddle their offspring with student debt, it’ll be easier for them to manage that than the alternative: supporting you down the line. So if you have limited funds, prioritize that retirement plan.
“That being said, you should save for both at the same time, if possible,” adds Dunn. “Maxing out your retirement contributions is the ultimate goal, but don’t wait to start saving for college until you get there. Find the right mix for you, and don’t forget to take advantage of any tax breaks offered through your state, like a 529 plan.”
Getting a Big Tax Refund
Instead: Withhold less and invest throughout the year.
Yes it’s gratifying to find a big check in the mail — but it’s also a sign that you’re passing up an opportunity to make a little extra dough. If the government is withholding too much money, that means it’s not being invested during the year, lowering your overall net worth. One exception: “Some people prefer to invest a large lump sum annually,” says Gimpel. “It’s easy to mindlessly spend an extra $40 a month on frivolous stuff, whereas it can be more compelling to put a $500 rebate into savings.”
Constantly Checking Your Account Balances
Instead: Check less frequently, but develop a good budget.
Being super on top of your financial situation sounds like a smart idea, but it can backfire. “It’s a relatively new phenomenon called ‘balance spending,’ where people log onto their online banking accounts constantly,” explains Dunn. “They want to remain aware of their funds, but this easy access has turned into a crutch that leads to overspending and a lack of budgeting.”
Rather than making financial decisions based on how much you have in your account at any given moment (“Looks like I have $1,500 in the bank, so I can totally splurge on these $200 stilettos”), develop and stick to a budget. Dunn recommends checking your online bank account only once a month — but instead of just glancing at the app for 20 seconds, carve out a chunk of time to really sit down and evaluate your finances from the previous month, and set goals and budget for the month ahead. “You won’t need to check your balance all the time because you know what is coming and going, and you’ve budgeted for each category of spending,” explains Dunn.
Making Extra Mortgage Payments
Instead: Put the money into investments and an emergency fund.
As long as you have a low interest rate, it makes more sense to invest your capital rather than funneling it into more mortgage payments. “Many people want to achieve the American dream of owning their home outright, and think that mortgages are dangerous,” says Edelman. “In fact, they’re an excellent tool to help you build wealth because they allow you to retain liquidity.”
As long as you can invest your money for a higher return than your mortgage’s interest rate, you’re better off going that route — or shoring up an emergency fund. (If your mortgage is 6 percent or higher, first refinance it down to 4 to 5 percent.) “In the event that you lose your job, having a mortgage payment isn’t much consolation,” says Edelman. “On the other hand, having $100,000 at your disposal is very powerful indeed.”