Yes, you can get richer by cutting out Starbucks, by cutting cable and watching Netflix instead, by clipping coupons and changing your baby’s diaper once ever four hours instead of every two. But while these are all good cost cutting ideas with the exception of the one that leaves your baby with diaper rash, they’re chicken feed compared to fixing some bigger mistakes most Americans make..
Most Americans could be a lot richer if they stopped making the eight common money mistakes we outline in our article below.
Some big money mistakes most Americans make include keeping up with the Joneses, not keeping a budget, not sticking to a budget, panicking when their investments lose value, not saving, not defining what wealth means to them, getting in debt and not taking advantage of company benefits. Together, these mistakes probably rob most Americans of more potential riches than any other factor.
The average American has about $16,000 in credit card debt and has saved enough for about six months of expenses by the time retirement age comes around. Keeping up with the Joneses is a very bad idea for anyone wanting to be richer. It might feel embarrassing to have smaller house, older car, less expensive clothes, a smaller rock on the finger and less selfies doing sun salutes atop Mt. Yerupaja. However, the accompanying inner peace of a big, soft financial cushion and less time spent scrambling financially can make life much more enjoyable.
Imagine two families. One has two new cars, a house they can’t quite afford and all the other trappings of wealth. The other owns two used but reliable cars, a smaller house and takes vacations closer to home every year. Both make a combined $100,000 a year.
Family #1 has two car payments totaling $800 a month, a $1,700 a month mortgage payment, spends $2,500 on the credit card every month and takes a $3,000 vacation every year. Family #2 has no car payments, a $900 a month mortgage, spends $1,500 on the credit card monthly and spends $800 on annual vacations.
Family #1 can hold their heads higher at dinner parties, secure in the knowledge that they’re maintaining the appearance of wealth. But the hard truth is that family #2 is much, much wealthier. After 30 years in fact, investing their savings at a modest 5% growth, family #2 has $2,330,00 more than family #1. If family #1 went into a store and saw a box marked “status and the appearance of wealth” with a two million dollar price tag on it, would they buy it? Answering “no” is a great way to get richer.
Budgeters tend to be about 20% richer than people who don’t budget.
The sad truth is, most Americans plan their vacations a lot better than they plan their finances. The upside of that equation is that it’s relatively easy to do better than most Americans in this regard.
A budget is just a plan for how to handle money. People who don’t follow a budget can’t be sure how they’re money’s being spent. They often feel out of control or at the mercy of external events. They know they’re spending money on rent or a mortgage, on groceries, bills, dining out and other necessities. They know they’re spending on some luxuries like dining out and entertainment. They know how much they make and roughly how much they spend, but there’s no plan and their finances can often take them by surprise.
By contrast, budgeters make conscious choices about how much they’ll spend in each category. Even when budgeters don’t stick to their plan, the plan is still there, giving them a target to keep aiming for.
It’s one thing to have a plan for how to spend money. It’s another to be faithful to it. The best budget in the world won’t help someone get richer if they don’t stick to it.
A budget can be compared to a person’s dietary habits. Going on a diet is fine, but diets seldom last. A dieter might cut out all sweets and eat a watercress salad twice a day with a spoonful of dry tuna, dutifully count calories and think they’re making a big impact. Such diets usually end up with binge eating because self-imposed starvation can’t be sustained.
Budgets are the same. Creating an impossible budget is better than not budgeting at all, but the really important thing is forming good spending habits. While the occasional splurge doesn’t hurt, those who make a budget they can actually stick with will generally fare better and get richer over the long term.
The biggest single piece of advice most financial advisers give their clients over and over again is, “Just leave it alone.”
According to a survey of 325,000 investors by financial management firm SigFig, hands-off investors earned 36 times the returns of those who tried to manage their investments. In other words, as billionaire investor and financial guru Warren Buffett says, invest the money and leave it alone no matter what the market says. People who follow that advice generally get richer. Someone who had $100,000 in stocks before the crash in 2008 likely saw their investments lose roughly forty percent of their value. Those who panicked and took their money out cemented that loss. Those who left their money invested have likely made back what they lost and then some.
If financial advisers and gurus and data are all giving the same piece of advice, then why do so many still make the mistake of trying to micromanage their investments? Probably because investing can be scary. It’s one thing to say, “leave your investments alone.” It’s another to watch the market lose twenty percent of its value and know your life savings is dropping right along with it.
As with sticking to a budget, the key here is discipline. Sweating the roller coaster ride of market fluctuations isn’t easy, but those who resist the temptation to cash in their chips usually get richer in the long term.
76% of Americans live paycheck to paycheck. That’s very bad. Unless that trend changes, it means three quarters of us won’t be able to retire. While saving can be difficult, fixing the money mistakes above like not budgeting and keeping up with the Joneses can help. Even saving $500 a month and investing it at moderate rates of return can make someone richer, making them a millionaire by retirement age.
A family in their mid-twenties who puts $500 a month into a Roth IRA and keeps doing that until age 65, getting a 6% investment return, will have just shy of a million tax free dollars in the account by age 65. A much more attractive option than continuing to live paycheck to paycheck during the golden years.
Someone who decides they must make $100,000 a year to the exclusion of all else might be missing the bigger picture. Why make $100,000? Is it because that amount will allow for enough savings to afford all the good things in life? Is that income worth working 80 hours a week? Does the extra money make someone richer if there’s no time to enjoy it?
Other considerations like free time, lifestyle, geographical area and recreation all have a place in the wealth calculation. Someone who makes only $30,000 a year but lives in a comfortable house in a beautiful natural area and works only twenty hours a week may count themselves wealthier than someone who makes ten times that amount and lives in a McMansion but works long hours and spends three hours a day stuck in traffic. Who’s right?
The answer is, it comes down to individual preference. The person who takes the time to decide which things besides money form their specific definition of wealth will have a much easier time getting richer.
The graph below shows how investments grow at an exponential rate. That means someone who saves $1,000 a month for 40 years doesn’t wind up with $480,000 ($1,000 x 12 months x 40 years). Instead, investing the money at 6% interest, they finish with about two million dollars. That’s because compound interest grows their invested money exponentially.
To take advantage of this compound interest power, a person has to have the ability to save. The second someone gets in debt, they lose that ability, and the magic of earned interest is lost to them.
Effectively, getting into debt will make a person a slave to money for the rest of their life. Not only are they unable to take advantage of earning interest on savings to get richer, but they’re on the other side of the equation. Now other people are earning interest from them. Someone who gets just $1,000 in debt and agrees to pay 15% interest, then fails to make payments would owe $267,000 forty years later. Debt is a trap that gets stronger the longer someone stays in it.
Most companies offer some kind of 401K or employee IRA plan. Many companies offer matching funds along with these plans. An employee who saves $5,000 a year in their own IRA could be missing out on an additional $1,250 a year in free money from their employer, just by failing to take advantage of the company’s 401K with matching funds.
Another excellent company benefit is tuition reimbursement. Some large company employers offer $10,000 a year or more in the form of tuition assistance for their employees’ continuing education. Even small companies can offer to pay their employees partially in education payments, which can render up to $5,250 of employee income tax free for the year.
Ignoring company benefits like employee retirement plans and tuition assistance is effectively throwing away free money. That’s a terrible way to get richer.
- Controlling Your Personal Debt – CNN.com
- Wealth Accumulation and the Propensity to Plan – National Bureau of Economic Research
- The Most Successful Investors Leave Their Money Alone – Finance.Yahoo.com
- 76% of Americans are Living Paycheck to Paycheck – CNN.com
- Employer Provided Education Assistance – IRS.gov