Many people gain their expertise in money management by trial and error. However, carefully monitoring your finances and giving them proper consideration can help avoid some common financial missteps, according to two Texas A&M University financial planners.
Nathan Harness, Ph.D., director of the Financial Planning Program, and Nick Kilmer, lecturer, both in the Department of Agricultural Economics at the Texas A&M College of Agriculture and Life Sciences, discuss five of the most common mistakes when managing money and offer advice on how to avoid them.
No. 1 — Being unaware of personal wealth
Wealth is perhaps the most important financial figure in an individual’s life. It has a tremendous influence on a person’s financial security and freedom of choice. However, many Americans do not know how to calculate their own personal wealth.
“Information is an incredibly valuable asset, often referred to as one of the most potent currencies available to individuals,” Harness said. “Financial freedom starts with the basics, such as understanding budgeting, saving, investing and debt management.”
Kilmer suggests starting the process by considering the scenario of losing your job and having to sell assets to pay off your debts. However, he challenges you to think about needing to do that while still having money to sustain yourself until you find new employment.
“This is too significant of a potentially life-changing situation to ignore until it happens,” Kilmer added. “You should update your budget and balance sheets on a regular basis to accurately reflect the current values of your assets and debts. You need to know for sure if you have a firm financial foundation to weather a sudden financial jolt and to be sure your wealth is trending in the right direction.”
Harness suggested shaking yourself out of financial complacency by reading and learning more about personal finance, networking in personal finance forums and finding professionals like financial advisers who are able to provide you with both information and guidance.
No. 2 — Not setting financial goals
An important step toward financial well-being – and one which many people ignore – is putting pen to paper and writing down financial goals. Financial goal setting adds purpose and drive to create wealth.
“Financial goals are the roadmap for your financial journey,” Harness said. “One of the key benefits of having financial goals is they bring clarity to your aspirations. And when these are clearly defined, motivation can more easily exist now that something tangible is identified that you can work toward.”
Kilmer said it is much harder to achieve goals if we don’t know specifically what we want to accomplish, so the details are crucial.
“Ask yourself, ‘what is my financial goal?’” he said. “If it’s to buy a house, then ask yourself ‘when do I want to accomplish that?’ Next, ask how much money you’ll need for a down payment and closing costs, then calculate how much you need to set aside monthly to accomplish this goal in your timeframe. If it does not fit into your monthly budget, then you need to adjust your financial goal to where it can be attainable.”
Both Harness and Kilmer said being unaware of where your money is spent can reflect a lack of ownership and control over your money, which can often lead to unwanted financial outcomes like excessive debt.
“When you don’t set financial priorities and goals, a lot of money can be spent on frivolous or insignificant items that do nothing for your net worth,” Harness said.
Kilmer said a good mental exercise is to project yourself into the future and set financial goals for that future self, such as buying a home, putting children through college, taking a dream vacation or preparing for retirement.
No. 3 — Not using a budget to monitor your net income
While not many people would consider it fun to build a budget, a plan for your income and expenses is the cornerstone to growing wealth.
“Making a plan to grow your monthly income and, where necessary, cut back on your monthly expenses, will allow you a greater chance to grow your monthly net income,” Kilmer said. He explained monthly net income can be defined as the amount of money left over at the end of the month once all your bills have been paid.
He said when you don’t track your spending, it can hinder your ability to save and know how much extra you have to invest at the end of the month. Without that clear picture of how much you can save and where your money is going, you would not be able to make informed financial decisions.
“Taking control of your money by deciding where each dollar will be spent is key in winning financially,” he said.
Kilmer said monthly savings can be used to buy income-bearing assets or pay down debts, growing your wealth and generating even higher net income for the next month, creating a wealth cycle.
“If we allow lifestyle creep, or just poor planning, to cause our monthly spending to get out of control, our income may not be enough, forcing us to sell assets or take on new debts to cover our unpaid bills,” he said. “Don’t let this happen; find a budgeting method that works for you and stick with it.”
Kilmer suggested tracking your spending for a month without changing the way you usually spend, then analyze where you can make corrections in how you budget and spend your money.
Both experts also suggested that budgeting should include making accommodations for an emergency fund of up to $10,000 in the event of an unexpected financial setback, such as a hospital stay, vehicle accident or job loss.
No. 4 — Paying interest versus earning interest
“You want your money to work for you instead of you having to work just to pay off your debts,” Harness said. “Understanding how you can be earning interest instead of paying it is important to your financial freedom and future wealth.”
Debt and interest on money owed are the enemy of positive wealth, so it’s important to be in a financial position where you are earning interest instead of paying it. However, financial experts agree it is important to build your credit since a good credit score can potentially save you thousands or even tens of thousands of dollars in future interest.
“Many young adults are naturally, and rightly, afraid of credit cards, but they are effective credit building tools when used correctly,” Kilmer said.
He said long before purchasing a first car or home, people with low to no credit should obtain a credit card and use it to build their credit for at least one to two years.
“Improved credit scores can provide better loan rates for such large loan balance items,” he said. “The trick with credit cards is to use them every month, wait for the credit card statement, then pay the statement balance in full — not just the minimum — before the billing due date. Repeating this process every month for a few years will build a solid credit history without charging you a dime in credit card interest.”
On the subject of earning interest, Harness said consider investment accounts such as certificates of deposit, mutual funds, stocks and bonds.
“Each person has to determine what investments are best for them and fit their investing style and comfort with risk,” Harness said. “With all investments, be sure to weigh the risk versus the potential benefit that comes with it. If you choose the right type of investment, your money will be working for you, building your net worth.
No. 5 — Postponing retirement planning
Time is undeniably our most valuable asset, Harness said.
“As Benjamin Franklin famously noted ‘lost time is never found again,’” Harness said. “This truth holds a particular significance in the context of retirement planning.”
He said by starting retirement planning early, you can tap into the power of compounding, make necessary adjustments to your strategies and reduce financial stress in the long run.
“With the general replacement of pensions by defined contribution plans, such as the 401k, preparing for retirement has fallen squarely in the laps of future retirees,” Kilmer said. “In fact, according to a recent report from Fidelity, more than half of Americans are not on track to comfortably pay for their future retirement.”
Another major factor affecting retirement planning is the uncertainty of whether the Social Security Administration will have enough money to pay off scheduled benefits in the future.
“Relying on your workplace or the government for the bulk of your retirement income can be a risky bet,” Harness said. “If your workplace has a retirement plan where they match your contributions, then you can invest in a 401(k) or 403(b). If not, you can set up a retirement fund, such as a Roth individual retirement account, on your own.”
Kilmer said it is vital to identify and track which retirement funds you hope to utilize in retirement and start estimating how much money you’ll need to survive – or even thrive – every year in retirement.
“You need to figure out just how big of a nest egg you need to accumulate,” he said “These types of financial calculations can be daunting for some. If you’re one of those people, then seek out the help of a professional financial planner sooner rather than later. They can walk you through this process and possibly give you some financial peace of mind.”
Harness and Kilmer said avoiding these management mistakes will give you better control of your finances and help ensure a more financially stable future. They said it is vital to know as much as you can about your assets and debts so you can make corrections where necessary and stay on track toward financial freedom.