We can’t blame the economy, President Obama, Congress, our employer or our ex-spouse for our lack of wealth. In my role as a financial educator and experience for 25 years as a financial planner, I have observed that most people’s financial problems for the most part are self-created. The financial mistakes I have personally made in the past were no one’s fault but my own – when I was being too optimistic or greedy in investments, and I ended up losing money. I can spot it right off when an employee calls our financial helpline, and is placing blame on circ*mstances or other people instead of looking for ways to take responsibility for creating their own wealth. There are, of course, callers who are a victim of circ*mstances they had no way of preventing--- like unexpected medical emergencies-- but those are exceptions, not the rule. From the work I've done with tens of thousands of individuals over the course of my career (myself and extended family members included), the cold, hard reality is that most working Americans could be dramatically wealthier if they made some changes in their focus and in their behavior.
In my experience, there are five things that hold most people back and keep them from becoming wealthy. Avoid these common mistakes and you can significantly increase your odds of becoming financially secure and independent:
They don’t save enough. The spend-to-save paradigm needs to be shifted from spending first and saving what is left over ( if anything) to saving first and foremost. I often quote one of my favorite books on creating wealth, and I am going to do it again. Thomas Stanley, author of The Millionaire Next Door, studied millionaires and multi-millionaires in the U.S. and found that on average they saved 20% of their income. The personal saving rate in the U.S. is sitting around 4.4%, which means the millionaires are saving nearly 16% more than the average person is saving now.
The benefit of saving 20% of your income is enormous. For example, a 30 year old making $75k a year that saves 20% in their 401(k) earning 6% would have $1.67 million in their plan at age 65. Contrast that with the average saver who is looking at $368k. This $1.3 million from a much higher contribution rate is a game changer at retirement. If everyone did that, we wouldn’t be having discussions about pre-retirees having to delay retirement.
They carry high-interest debt. A prevailing theme I’ve seen over the years is people not really understanding how much their high-interest debt is really costing them. Even with the changes in required reporting from credit card companies, many people don’t realize the actual cost. I’ve sat down with countless numbers of people who have a department store card or a home improvement card, and when I ask them what interest rate they are paying, they are often shocked that it is close to 30%. That wood floor just cost them thirty percent more than they thought.
The average balance for people who carry a balance on their cards is over $15,000. With an average interest rate near 15%, the interest alone could cost tens of thousands of dollars over a lifetime. But the true costs are much higher. Often not factored in is the opportunity cost – that $1.3 million game changer we just talked about. Because funds were going out to pay down debts, they never made it to the wealth building account so you weren’t able to save 20% of your income. Carrying a credit card balance could cost a lot more than tens of thousands of dollars in interest.
They make investment decisions based on emotion. Studies have shown that investors who try to time the market end up selling at the wrong time – when the market is down – reducing their overall returns on their investments. I know firsthand it can be tough to stick to a strategy, especially when the strategy is to hold and “do nothing” when the market is fluctuating. Often the first instinct to take immediate action is the wrong move. According to a Fidelity Study analyzing participant actions from October 1, 2008 through the second quarter of 2011, 401(k) investors who moved their assets to cash during the 2008-2009 downturn and stayed invested in cash achieved a 2% gain as of June 30, 2011. Those who stayed fully invested, i.e., stayed put, achieved an increase of 50% during the same time period.
Investors who sought “help” ended up having average returns almost 3% higher than those that didn’t. The study by Aon Hewitt and Financial Engines included three kinds of help: advice from a financial professional, an online financial learning tool, and the use of target-date funds in a 401(k). The bottom line was the education paid off since more participants stuck with their strategy instead of trying to time the market. Using the median annual returns from the study, an employee who sought help investing $10,000 in their 401(k) would have ended up nearly $30,000 wealthier than the investor that did not seek help. Having a financial advisor to develop a strategy and help you stick to it may be one of the best decisions you can ever make.
They spend large amounts of money on depreciating assets. A friend of mine buys a new car every three years. According to Edmunds.com, a new car depreciates in value by 11% the minute you drive it off the lot, and since it only retains about 58% of its value after three years, my friend is in a losing cycle. If he is buying a $40k car, he’s losing about $17k in the first three years to depreciation. In his case, since he really loves new cars, it makes sense to buy new and drive them until they drop. For others, it makes sense to buy two or three year old vehicles instead, since someone else has already taken the hit on the initial depreciation. The key is to stop sinking money into assets that are sinking as well.
Rent is another example of spending money on a depreciating asset. Actually, when you pay rent, you are essentially paying someone else’s mortgage payment, which builds their equity in an asset that may actually appreciate over time. Many people today regret buying a home and think it was the worst investment mistake they’ve ever made because they are underwater and haven’t seen any appreciation yet. Owning a home is a long-term investment, and in many areas of the country the housing market is starting to gain traction. Even if it never does, owning a home may still be a wealth building proposition for two reasons: you are locking in your housing costs with a fixed-rate mortgage while rents continue to rise, and your mortgage will be paid off at some point in the future. When that day comes, you’ll substantially reduce your expenses allowing you to live on much less.
They start a plan too late. Probably the most common complaint I have heard from people when doing retirement planning is they wish they had started earlier. Starting early makes a huge difference and in fact, I feel so strongly about it, I volunteered to mentor new employees in my company’s Financial Wellness program. As part of their training, we ask them to run a retirement plan calculation to show what a difference waiting ten years makes. As a theoretical exercise, it is interesting, but when they put their own information in the calculator, the difference takes their breath away. If they start investing at 30 with $10,000 a year in the 401(k) earning 6%, they would have $1.15 million at age 65. If they wait until age 40, they accumulate $566k instead. Over that 10 year period they may have contributed $100,000 less, but they have $584k less in wealth. That $584k is another game changer and could be the difference between being able to retire or not. (Click here for the calculator.)
Wealth building isn’t reliant on economic conditions, though favorable ones can certainly help. Fortunately, the factors that have the biggest effect on building our wealth are actually things we have control over, the most important being the amount of money we save. In all my years as a planner, I have never heard this complaint, “I saved too much money.” Now, that said, we don’t always have control over starting early. For some of us, “early” has already passed, but we do have control of what we do from here on out.
Nancy L. Anderson, CFP ® is Think Tank Director and Resident Financial Planner at Financial Finesse, the leading provider of unbiased financial education for employers nationwide, delivered by on-staff Certified Financial Planner™ professionals. For additional financial tips and insights, follow Financial Finesse on Twitter and become a fan on Facebook.
