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Monday, June 17, 2024

5 Most Common Money Traps to Avoid

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For many of us, managing our personal finances can be about as fun as doing our taxes. But just like software can make the tax process easier, there are specific things you can do to make money management as painless as possible. Below are five common money missteps and what you can do to get on track.

1.  Delaying saving for retirement. It’s easy to put off saving for retirement when you’re in your 20s—it seems far-off and making a day-to-day budget work may be challenging when you’re starting a career. Soon enough you reach your 30s, and your priorities may shift to saving for a house or paying for childcare—still not an easy time to save for retirement. The fact is, it may never be easy. But it will always be necessary. And yet, a quarter of American families don’t have any retirement accounts at all.1

The fix: As soon as you start a new job, sign up for your employer’s 401(k) plan. If your employer doesn’t offer a 401(k), set up an individual retirement account (IRA) and automate your monthly deposits. If you don’t get used to having extra money in your paycheck, you won’t miss it when it automatically goes into your retirement savings. Plus, if you start early, your earnings will have a chance to generate more earnings, growing your savings at an accelerated rate over time—that’s the power of compounding.

2.  Skimping on an emergency fund. Twenty-four percent of all Americans have no emergency savings set aside to cover home repairs, medical bills, temporary unemployment, or any number of unforeseen (and pricey) expenses. Close to 75% don’t have six months’ worth of expenses saved, and only one in five people have three to five months’ worth of expenses saved, according to an August 2020 Bankrate.com survey. 

The fix: Stash away three to six months’ worth of cash in a separate account to cover essential living expenses. The number may be daunting, but you don’t have to get there overnight. Funnel part of your paycheck automatically to a separate account and you’ll make steady progress over time. And remember to increase your savings rate as your earnings—and cost of living—go up.

3.  Taking the short view on investing. Given the bear markets earlier this year or from 2007 to 2009, it’s easy to understand why so many investors react rashly when the market takes a dive. The Dow Jones Industrial Average lost about 20% of its value between February to March, and more than 50% from its peak in October 2007 to its lowest point in March 2009. But it’s the investors that have the fortitude to buy and hold who tend to prevail: The market has now generally recovered, and from that rock-bottom point in 2009, the Dow Jones Industrial Average has risen more than 20,000 points. Investors who cashed out earlier this year or back in 2009 may have locked in losses and consequently missed some or all the upswing.

The fix: Stay invested. If you have a history of making investment transactions right after a major event, consider reducing the number of times you log in to view your account—say monthly or quarterly. Remember: Day-to-day market fluctuations have little impact on your long-term goals. Bear markets typically come to an end and research shows that staying invested over the long haul—and not trying to time swings—can be the best way to participate in the market.

4.  Avoiding the market. Market volatility may be scary, while past performance is not guarantee of future results, there has never been a 20-year period when stock returns were negative. Keep your time horizon in mind when you’re investing in stocks.  Having most of your money in the stock market can be quite reasonable for a young person when investing for retirement. You should consider some exposure to stocks, even during retirement

The fix: You don’t have to jump in cold. Get in the habit of investing by moving a portion of your cash savings into a diversified portfolio each month. This approach, known as “dollar cost averaging,” ensures you buy more shares of an investment when the price is low and fewer shares when the price is high. If you have a significant amount of money to invest, dollar cost averaging will reduce the impact of market volatility on large purchases.

5.  Concentrating your investments. Some of us might have too much of one type of investment in our portfolio. Maybe it’s stock in the company we work at, or municipal bonds inherited from a relative. But there’s a benefit to owning many different types of investments. Having that variety in your portfolio—called diversification— tends to reduce its volatility and risk. Each investment responds differently to changes in the market or economy. If geopolitical events shake up your international stocks, for example, U.S. bonds might rise and help smooth out your portfolio’s return overall.

The fix: Make sure that you have investments across numerous sectors, industries, and geographical areas. Once you have a diversified portfolio in place, revisit your portfolio’s allocation mix on a yearly basis to make sure it still aligns with your investment goals.

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