The Ten Worst Money Mistakes Anyone Can Make

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I’ve said many times that success in managing personal finances is pretty simple: spend less than you earn over a long period of time. If this is the heart of your financial plan, it's likely that you’ll be prosperous.

That said, there is one other thing you’ll need to do – you must avoid the financial pitfalls that can significantly derail your finances. I call these the worst money moves anyone can make. I'm listing them below in countdown fashion along with some suggestions for avoiding them. Here are the top ten IMO:

10. Not having an emergency fund.

An emergency fund is your first line of defense against unexpected financial problems.

And believe me, unexpected financial problems happen rather regularly. Washing machines break, cars need repairs, kids need braces, and so on. It’s a fact of life.

If you don’t have an emergency fund, you will likely have to borrow money when an emergency pops up. And as we’ll see soon, borrowing is an even worse money mistake.

So how much should you save in your emergency fund? There's actually a scale of different emergency fund suggestions based on your financial/work/life situation but a good rule-of-thumb is to have six months’ of living expenses saved up. In addition, be sure to keep your emergency fund in a safe place -- you certainly want it to be there when you need it. Don’t worry about earning a ton on it, no one ever became rich by making money off their emergency fund, just make sure it’s safe and accessible.

9. Neglecting to make a will.

Money magazine reports that 57% of Americans don’t have a will, including 69% of parents with kids under 18.

Without a will, guess who decides what happens with your finances and your kids? The state! Do you really want to let your state decide these issues for you?

To avoid this bad money move, you need a will and the other documents that account for good estate planning – probably at least Patient Advocate and Medical Records Release documents for most people. For some guidance, see Four Documents You'll Need as Part of Your Estate Plan, Five Questions to Choosing a Guardian, and 12 Critical Things Your Family Needs to Know.

8. Not having enough insurance.

I think of insurance as a very big emergency fund that supplements your cash emergency fund. It covers the things you couldn't save up to cover in advance, helping to replace/protect the largest assets you have – your career, your home, your investments – if you experience a major accident, death, or injury.

I've already detailed the types of insurance we all need as well as some general guidelines for each of them. In addition to that list I'd add umbrella insurance to cover general liability – in case you’re sued for one reason or another (and we all know what a sue-happy country we live in these days.)

One more bit of advice: do not go overboard and become over-insured. No one needs to win the lottery when misfortune occurs (for example, your family most likely does not need a $10 million life insurance policy on you. If you have one and you don't make $1 million a year or so, you're probably spending too much on life insurance.) But you do want to be sure you have enough insurance to replace your assets in times of trouble or loss (for example, you want life insurance to cover these costs).

7. Marrying the wrong person.

There are actually two major financial mistakes related to marriage: marrying a spendthrift and getting divorced.

Couples where both spouses know and apply financial basics do much better than ones where one or both spouses have bad financial habits. The Millionaire Next Door says:

What if your household generates even a moderately high income and both you and your spouse are frugal? You have the foundation for becoming wealthy and maintaining your wealth. On the other hand, it is very difficult for a married couple to accumulate wealth if one is a spendthrift. A household divided in its financial orientation is unlikely to accumulate significant wealth.

In addition, a divorce is a major hit to any couple’s finances. According to the Journal of Sociology, those who divorced saw their wealth shrink by 77 percent – a larger decline than would occur by simply splitting a couple’s assets in half.

So here’s some advice regarding money and marriage:

• Discuss finances prior to marriage (here are some questions to ask).

• Marry a money-wise spouse. 

• Stay married – if you have financial issues, seek counseling or financial help.

• Share in financial decisions while married.

6. Not saving.

As I noted earlier, the formula for financial prosperity is pretty simple:

• Spend less than you earn

• Do this for a long time

If you do these two things, you will be wealthy. Why? Because you’re saving money.

On the other hand, if you’re not saving, you’re not making progress financially. And the longer you wait to save, the harder it will be to catch up later.

The proper financial move is to save a portion of every paycheck you receive. A good rule-of-thumb is to start out by saving at least 10% of your income, and from there the amount should increase over time.

And some may ask just what you are saving for? Any major expense you know you’ll have in the future: a house, retirement, cars, college costs for kids, etc.

5. Buying too much house.

A house is probably the biggest purchase most of us will ever make. And unfortunately, many people buy homes incorrectly:

• They let a bank or real estate agent set the amount they are able to spend on a home.

• Then they find a home they "love" that is even more expensive than that.

• So the home becomes a financial stretch to the point where they can barely make payments – as long as nothing goes wrong.

• Then something goes wrong – which it always does because life happens.

• But because things are so tight, when a money issue occurs (sickness, pregnancy, unexpected expense, and so on) everything falls apart financially (or at a minimum it starts the financial drop).

Instead of that, here’s my formula for buying a house:

• Buy a house you can easily afford – one where you can make payments and still have some financial cushion.

• Put at least 20% down.

• Put extra payments into your budget as well as bonuses, gifts, second job income and all other “extra” sources of money into paying off the loan (assuming you have no other debt).

• Become debt free in 7-10 years.

That's what we did and it worked like a dream.
 
For those of you who want a bit more, the book Stop Acting Rich gives more precise rules:

If you’re not yet wealthy but want to be someday, never purchase a home that requires a mortgage that is more than twice your household’s annual realized income.

4. Waiting to invest.

There are three factors that determine how well your investments (savings) perform:

• The amount that’s invested (how much is invested)

• The return rate on your investments

• The length of time they are invested

Most of what we see in the media deals with getting the best return on your money. But actually, the factor that most influences the value of your investments is the time you have it invested.

And the longer you wait to save and invest, the more you’re costing yourself.

Here’s an example (PDF) that illustrates the power of saving early:

• Smart Saver starts saving $3,000 every year, starting at age 20. After 10 years, her $30,000 total contributions are worth $47,000 (at an annual growth rate of 8%). At age 30, Smart Saver stops saving and makes no further contributions. She just lets the money grow at an 8% annual rate of return for the next 30 years, until age 60. At age 60, the $47,000 will have grown to $472,000.

• Her sister, Late Saver, waits until age 30 before she starts saving $3,000 a year. Unlike her Smart Saver sister who stopped saving after 10 years, she doesn’t stop saving. She saves every year for 30 years, from ages 30 until she is 60. At age 60, her account is worth only $367,000.

Now I'll add a couple extra points to this example to show how Smart Saver could really have made it big in saving and investing for retirement:

• If Smart Saver would have kept saving $3,000 her whole life, she would have ended with almost $835,000.

• And if that $3,000 would have been $5,000, she would have ended with $1.4 million.

So the solution for this money problem is to:

• Save early

• Save often

• Save more (as a percentage of your income) as time goes by

3. Being deep in debt.

I have noted previously that leading investing company Morningstar says that, “Over a lifetime, the average American will pay over $600,000 in interest.”

$600k? Ouch! This is a pretty big example of the fact that debt is very costly -- it can rob you of hundreds of thousands of dollars.

The solution to this mistake is simple:

• If you’re in debt, start taking my steps for how to get out of debt today.

• If you’re not in debt, don’t get into debt.

2. Not working to maximize your career.

I’ve stated (again and again) that your career is your most important financial asset. This is because the average American can reasonably expect to earn in the neighborhood of $2 million during his lifetime. But if that person works hard and grows his income at 8% per year, he could have more than $3 million more than that. If he doesn’t, his $2 million can dry up to a bit over $1 million (or even less). So not working to make the most of your income can cost you millions of dollars.

To avoid this bad money mistake, simply develop and execute a plan to make the most of your career.

And let me add a couple other mistakes you do not want to make because they can derail your career and your income as well:

• Do not quit your job without another job lined up. Yes, it may be stressful to work where you do, but not having enough to eat is much more stressful.

• You must take care of yourself physically. Eat well, get plenty of rest, exercise, and enjoy life. Your career and its earning potential are dependent on you being able to work.

1. Over-spending.

If your outflow exceeds your income, then your upkeep will be your downfall.

The first step to gaining wealth is spending less than you earn -- it’s vital to making any financial progress. So when you over-spend, you’re doing the most damage possible to your finances.

Here’s what Stop Acting Rich says about the issue:

Most people will never earn $10 million in their lifetime, let alone in any single year. In fact, most households (97%) are unlikely to ever earn even $200,000 or more annually. So what if you are unlikely to become rich by generating an extraordinarily high realized income? The only way you will become rich is by being like those millionaires at the other end of the continuum: by living well below your means, by planning, saving, and investing.

There are two types of over-spending that can ruin your finances:

• Over-spending on the little things – the small amounts that seep out of your pockets here and there and eventually become large.

• Over-spending on the big things – homes, cars, boats, cottages, and so on.

The top complaint I hear from people who don’t have balanced budgets is, “I don’t make enough money.”

I’m telling you that in the vast majority of cases (probably 95% or more), it’s not the amount these people make – but the amount that they spend that’s the problem. (In some cases it's true that people simply don't make enough money to save, invest, etc. As such, they need to concentrate on increasing their income as much as they need to control over-spending.)

My wife and I once counseled a guy who made $130,000 a year. This was back in the early ‘90’s, so $130,000 was worth something (it’s still pretty good today.) When I saw his income, I thought “this will be a piece of cake” to make a balanced budget. But once we got through the mortgage on the mansion he owned, the four luxury cars he leased for himself, his wife, and his kids, and the amounts they spent on clothes and vacations – they had spent it all and then some.

And people who make much, much more can spend it all as well. Here’s a quick review of several wealthy people who spent more than they made – despite the fact that they made a bundle:

• Mike Tyson -- The famous boxer reportedly earned $300 million in his career, but it wasn’t enough to support a lavish lifestyle. He filed for bankruptcy in 2003, owing $27 million.

• MC Hammer – Despite a former $33 million income, he filed for bankruptcy in 1996.

• Scottie Pippen – The former Chicago Bulls star lost $120 million in career earnings due to poor financial planning and bad business ideas.

• Evander Holyfield - Four-time boxing champ reportedly made over $250 million in cash during his boxing career, but despite this he is now flat broke.

• Some others who made big money and spent it all and then some include: John Daly, Nicolas Cage, Bernie Kosar, Gary Coleman, Kim Basinger, Don Johnson, Michael Vick, Andy Gibb, Isaac Hayes, Lenny Dykstra, Latrell Sprewell, Mick Fleetwood, and Marvin Gaye.

This is why over-spending is the #1 money mistake – because no matter what your income is, if you spend it all plus some, you’re going backwards financially and you’re losing ground.

What to do to combat this: develop a budget and live on it.

I've talked about the 10-10-80 budget – give 10%, save 10%, live on 80%. IMO, this is a good, simple budget to begin with.

From there, the 10’s should get larger as you give and save more through the years. The 80% should become a smaller number over time. You may still end up spending more in total because your income is rising too, but as a percentage of what you earn, spending should decline as income increases.

So, that's my list of the worst money mistakes anyone could make. What do you think of it? Did I miss anything? Is the order wrong? Feel free to add your thoughts in the comments below.

Comments

[Arimack]

Agree wholeheartedly but I wanted to comment on the 10-10-80 plan, specifically the 10% saving that should grow over time. The way I chose to look at it was to focus on keeping the 80% I live on as small as possible over time. I was given advice when I first started to work. I was tol to take 50% of every raise and save it before I ever got used to spending. Every raise I ever recieved, I added to my savings first (generally 50% of any new raise become a new automatic monthly investment in a mutual fund.) This way, I never got used to the higher income, I continued to live at my previous income. Our savings rate quickly balooned over time to now where we live closer to 30% savings monthly (10-30-60).
This has not always be a hard and fast rule as our lifestyles have changed. Major life changes like marriage, birth of children, adjustment to a single income household, purchase of a home, etc have caused us to temporarily suspend our savings increases. But every January, we relook at our balances and adjust our investing. We have been very successful dedicating 50% of every salary increase to savings each time you recieve a raise.
By focusing more on controlling the spending, the savings came easier. Unlike most of my peers where I work, I live on a budget much closer to someone who is just starting out than someone approaching retirement.

[Squirrelers]

These are great guidelines. I like the parts about marrying the right person, and staying healthy. Your health, wealth, and relationships are all interrelated - which is a foundational concept for my own approach to personal finance.

[Nick]

Very good article, thank you. I would also add investing in financial products that you don't understand, not in place of any of the above because I couldn't really knock any of those out of a top ten but a very bad mistake to make in any case

Also how about not living by a budget?

[Khaleef @ KNS Financial]

Great article. All 10 of these things can cripple your finances! Hopefully many will read this and avoid those mistakes! Thanks for posting!

[Meg]

Good article! You do realize, however, that in some high-pressure professions, taking care of yourself is directly at odds with maximimizing your career, right? I've worked in several places where healthy habits were frowned upon because they took time away from billable hours. Ulcers, poor diet, lack of sleep, and messed-up relationships were seen as badges of honor. Not something I'd aspire to for the sake of career, that's for sure.

[LotharBot]

I'm surprised that the list doesn't have a single entry for "invested in the wrong things". Seems to me a lot of people's big money mistakes involve putting the money in the wrong investment vehicle, in one of these ways:

1) chasing past returns - investing in a fund that went up a lot last year, or buying into bubble-housing fearing they'll be priced out forever, or buying gold after it's tripled in price. The net result is that the investor loses a big percentage of their principle once the asset settles back to a normal level.

2) trying to beat the market - investing in high-expense funds that don't particularly outperform the market (and may drastically underperform), leading to minuscule real returns after expenses.

3) not paying attention to allocation - reaching retirement age with 100% of assets in stocks, and then getting burned by a market drop, or being young and stockpiling cash in a low-interest savings account and actually losing value relative to inflation.

4) wasting money - investing in uncle Fred's stupid business idea, falling for a scam, dumping huge amounts of cash into pointless seminars, getting involved in MLM, joining a cult, and so on. Simply results in hard-earned money disappearing into the void.

I'd bet many people make mistakes 1-3 in their 401k's, and it'll cost them a lot over their lifetimes. And a lot of people have stories about mistake 4, where they put a bunch of money into something and got little or nothing out of it.

[Budgeting in the Fun Stuff]

Great list! I need to work on the maximizing career point, but we're doing really well with not waiting to invest.

[mysticaltyger]

Good point about marrying the right person and staying married. However, how come I have never read any blog or article mention that having kids out of wedlock is a major financial killer? It's obvious, but never mentioned. Since more than 1/3 of US kids are born out of wedlock, I think this issue needs to be brought up, even if it's not politically correct.

[LotharBot]

In light of my previous post, here's my revised list:

1 - marry the wrong person. This is #1 because it can undermine or undo all the good things you do in every other area, and it can go on for your whole life (even if you get a divorce, support payments can continue.)

2 - overspend. By definition, if you're spending everything you earn, you can't be saving or investing. If you're spending even more, you guarantee you can't save or invest some of your future income because it's already been spent.

3 - be in debt. $600k of interest over a lifetime? That's a big money mistake.

4 - invest in the wrong things. If paying $600k of interest is bad, these things are equally bad: foregoing $600k of returns because you didn't invest in appreciating assets; seeing $600k of capital losses because you bought into a bubble; throwing $600k down the tube on bad business ideas or scams.

5 - slack on your career. A $5k raise early in your career is worth $200k, not counting interest/returns, and probably half a million or more once that's added in. Doing mediocre work and getting mediocre raises means you give up a lot of money over time.

6 - live in the wrong place. This can be a case of buying too much house, buying a house with unforeseen problems, living in a high-cost-of-living area without good reason, renting when you should've bought, or buying when you should've rented. Housing is a big chunk of expenses, and picking it poorly can be an expensive mistake.

7 - spending too much on college. Getting an expensive degree in a low-paying field, or getting a degree at an expensive out-of-state school when you could've done it for a third as much money at the same quality in state, or spending more years than are really appropriate... all ways to start your adult life with too much debt.

8 - neglect saving. Either getting started late or just not saving enough overall. (This is a combination of the original list's 6 and 4.)

9 - inadequate emergency coverage. This includes an emergency fund to cover "normal" unexpected costs, and insurance to cover the more extreme cases.

10 - not having a will. It doesn't hurt you financially, but it can be expensive for your next-of-kin to sort out with the courts.

[jim]

Good list.

[bb]

I think the number one mistake is to not invest in your financial education. Personal finance isn't taught in school. Whatever we do learn by our family, friends, coworkers and the media are usually false.

If you want to be rich, study what the rich do. It's simple but not easy. You'll find that they typically do the opposite of what the poor and middle class do.

[BD]

Yes, you missed something VERY vital. Under #2) Not working to maximize your career, you should have added: "Make sure you pick a career that pays a decent amount of money. DO NOT 'do what you love' just because you have a lot of yes-men in your life saying 'ALL YOU NEED IS PASSION! You can make a living wage at any career!', because that advice is false, false, FALSE."

I followed my dreams to become a graphic designer, because I was sure that all I needed to do was be passionate about it, and 'do what i love' and the money would follow. I found out the hard way that life doesn't work this way. Some jobs are over-saturated, and have too many people doing them, and not nearly enough work, not even enough to employ half of the people who need jobs in that field.

You could be the most diligent saver, the best budgeter, the most frugal person, but if you can't earn enough money to even begin to put a roof over your head, it's all for nothing. And "falling back on a retail job" doesn't work either. There are too many retail stores out there who refuse to hire a college-educated middle-aged person, for fear they'll bail when they find a "real" job.

So before you even think about any money mistakes, you have to be sure you have a GOOD career, one that pays well, and has a lot of jobs out there, or else any money advice is pretty much a moot point.

[Debbie M]

Another way to not maximize your career is to go to prison. You aren't earning while you're in jail, and certain offenses reduce your employment options.

Drugs and guns don't mix, even if they are both just sitting in the trunk of your car and you have a concealed carry license. (Sorry, I'm in Texas, and a bunch of us are in jail.)

Another way to not overspend is to not waste money. Almost no one wants to spend money on traffic tickets, parking tickets, bounced checks, late fees, library fines, IRS penalties, and the like. Nor do you want to spend money on things that fall apart instantly or cause you injury. Most people buy things they don't actually want because other people expect them to, they think they should want it, it didn't occur to them not to buy it, etc.

[Thisiswhyubroke]

"I have noted previously that leading investing company Morningstar says that, “Over a lifetime, the average American will pay over $600,000 in interest.”

This is SO important. I'm glad you brought this important fact up!!

"Because credit crack is wack"

[Steve]

MUCH OF WHAT YOU SAY MAKES SENSE. But, as far as insurance goes? forget it!Its the biggest scam going. No one on the planet needs life insurance.

You cannot spend it cause your dead. Only one who can spend it is your wife(or husband) once your gone,and if you took care of the finances while still alive,then there is no need for insurance.

Another thing. I would say for the biggest crowd reading this(perhaps 75 % of you), your NOT going to save your way to wealth. Saving is the small part(investing is the meat).You save enough to get started investing in say real estate or bonds ,or stocks,something where you can reasonably expect and 8 + % return ,and I'd really be looking for more than 8 %.

Never hire someone else to do your investing or handle your money in any way. That is only asking to be ripped off.Educate yourself and do your own investing and money management.

[FMF]

Steve --

Yes, you should be working towards being self-insured, but that takes time (decades). And in the meantime, you need life insurance to provide for those that you leave behind in case of your premature death.

[mysticaltyger]

The only thing I see missing from the list is not having kids out of wedlock. Seems like a no-brainer to readers of this blog, but over 1/3 of kids today are born out of wedlock. Doesn't bode well for the financial future of either the parents or their kids.

[Laura]

if you live less than 2 miles from work, school, and the grocery store, you don't need a car or a gym membership. walking or bicycling is, well, FREE! it's also good for the environment and excellent for your health.

[MortgagesByMark]

Your number 5 is a great point. I have a post that will be coming out in a few weeks on my site that does a detailed analysis of why it's beneficial to buy LESS house now. People that do so can catapult themselves financially far ahead of those that buy their dream home right out of the gate. Buying a house that is easily affordable not only gives you peace of mind, but it reaps huge financial dividends in the future as well.

[Patti]

Another comment about #5. Don't move every few years. That will allow you to pay off your house before retirement (7-10 yrs). Your house/rent payment is usually your biggest monthy expense. If you have no house payment, you can live on much less during retirement than most people.

Also, beware when building a house. Builders usually go over budget at least 20%. Figure that into the price of your home so you don't end up in a home you can't afford.

[mari]

All excellent points. I'd emphasize marrying the right person - but of course no one consciously marries the wrong person....except maybe marrying a person with credit card debt, a bad credit report, frivolous habits, expensive hobbies etc and thinking they will change.

I'd add not lending money to adult children unless it is absolutely necessary for health or other extreme situations. Many of my friends have done this and frankly the "kids" (almost always male) never grow up, live at home, work marginal jobs (or not at all), get money for lawyers to keep them out of jail, etc. These are not disadvantaged kids - the kids I'm thinking of are sons of 2 doctors, 3 lawyers and a business owner.