Whether you make $50,000 a year or $500,000, the way you manage your money can make a big difference to your future. Failing to prepare for a catastrophe could leave you wiped out and starting over if the worst happens. Meanwhile, improperly managing your investments could also leave your portfolio – and your future – vulnerable.
Here are 13 ways you might be shorting yourself and what you can do to protect your financial future.
1. Inappropriately assessing risk
“The number one thing that holds people back from accumulating wealth is inappropriately assessing their risk,” says Joseph Sweis, CFP, founder and managing partner of Pearl Wealth Advisors in Walnut Creek, California.
This risk assessment error breaks down into several subcategories (see No. 3, No. 4 and No. 10 below for prime examples). For instance, you might be underinsured or have all of your investment eggs in the same basket. Whatever the cause, Sweis says, a change in your attitude may be the most important thing you do to build your wealth. Instead of assuming your future will be sunshine and roses, hedge your bets in case it isn’t.
2. Going it alone
Some people may not know how to manage their own money or be unsure of who to turn to for help. By reaching out for professional help, you can make sure you make the most of your money.
“I think it’s more than not knowing they need help,” says Lorenzo Sanchez, CFP, director of wealth management at Rowling & Associates, a San Diego-based investment firm. He likens this attitude about money management to a young person who doesn’t go to the doctor regularly because they don’t have health problems.
There may be another opportunity cost to going it alone.
“The Google computer science engineer is capable of filing their own tax return,” Sanchez says, but points out that the engineer is probably better off spending his time on something else. Plus, he might pay for his DIY tax preparation with costly errors.
3. Not carrying enough personal insurance
Many people don’t have disability or life insurance, or don’t have enough coverage in these categories, Sweis says. NPR has reported that 41 percent of employers offer long-term disability insurance, but it may be a benefit that you have to opt into.
“They think (disability) is one of those things that happen to somebody else,” he says.
The Centers for Disease Control and Prevention reports that a quarter of Americans have some kind of disability. While some disabled people are able to work, a temporary illness that prevents you from working can mean financial disaster if you’re underinsured.
Sweis emphasized the importance of planning for catastrophic events, too.
“They have a low probability of occurrence, but if they do, they have a high impact,” he says.
Make sure you are covered for whatever happens with disability, long-term care and other insurance coverage to protect you from catastrophe.
4. Underinsuring your home
Your home may be underinsured and you may not even know it, Sweis says. If you simply renew the same policy every year, your existing limits may not cover the increasing value of your home over time. You also may need to get supplemental insurance if you live in areas prone to flooding, wildfires or earthquakes.
“Think about the California fires,” Sweis says, noting that many of the people affected didn’t have enough homeowners insurance to cover rebuilding costs. “When their houses burned down, they weren’t compensated for what the home was worth.”
To ensure you’re adequately protected, Sweis recommends purchasing an umbrella policy. An umbrella policy provides additional insurance above the limits of your other policies. For example, if you were in a car accident that resulted in $100,000 of expenses and your auto policy only covered $50,000, the umbrella policy would pick up the rest.
Before you renew your homeowners policy, he suggests you make sure that your limits are high enough to cover the current value of your property. If not, work with your insurance agent to get adequate coverage for your home.
5. Making emotional investment decisions
Anxiety about short-term losses can lead you to make irrational decisions, and that can cost you in the long term.
Sanchez defines emotional trading as taking an action such as “going all cash when the market drops.” One way to avoid this mistake is to hire a professional to manage your investments.
“That’s one of the advantages of (using) a financial planner is that I am unemotional about your money,” Sweis says.
If you manage your own portfolio, staying committed to your investment plan will help you avoid snap decisions. If there’s a market downturn, don’t make any rash changes. Unless you’re close to retirement, you can probably ride it out.
6. Investing too heavily in a single asset
Being overcommitted to one investment can spell disaster if it fails to pay off, Sweis says.
The asset could be your home, and you could end up house-rich and cash-poor if you overspend. If you own a business, you might have all your capital tied up in equipment or stock. Tech employees with stock options may have all of their investments concentrated in their company stock out of a sense of company loyalty, Sweis points out.
Overconcentration in one asset might be necessary at times, but it’s generally best to diversify your investments, he advises. If there’s a downturn and the asset you’ve poured all of your money into loses value, you won’t be wiped out.
7. Not maintaining your cash flow
Overconcentration can also lead to restricted cash flow, Sweis says.
For example, if you buy a home at the top end of your budget, or focus on prepaying your low-interest mortgage early, you tie up your monthly cash flow in the property. That can be problematic if you aren’t paying down high-interest debt, saving enough for retirement or beefing up your emergency fund.
“Make sure that, post-purchase, you still have strong, positive cash flow,” Sweis says. “Cash flow is the bloodline of anything you want to do in life.”
8. Missing out on workplace benefits
Many employers offer discount programs and benefits through third-party companies for their employees.
“A lot of people don’t know that they have benefits they aren’t taking advantage of,” Sanchez says. “Someone’s paying for them so you might as well use them.”
One example Sanchez cites is discounted legal services. This could save you hundreds or even thousands of dollars when hiring an estate planning attorney to prepare your will or trust.
Sanchez suggests reviewing your workplace benefits regularly so you can take advantage of all the money-saving perks your employer offers.
9. Misusing debt
Consumer debt in the U.S. reached an all-time high of $13.3 trillion at the end of 2018, according to Experian. Mortgages make up the bulk of that debt, followed by student debt and auto loans. Debt has it uses, but you should be cautious about how much of it you take on and in what form, Sweis says.
“Good debt is when you use leverage to build your wealth,” Sweis says. One example: buying an investment property that generates income. Bad debt, however, can drain your income. This includes running up balances on high-interest credit cards or taking out unnecessary auto loans.
“Bad debt is where you use leverage to buy a depreciating liability,” Sweis says.
Don’t overextend yourself, even with good debt, Sweis cautions. Otherwise, you’ll overpay in borrowing costs and reduce monthly cash flow.
10. Not monitoring your asset allocation in your 401(k)
Once you start putting money into a 401(k) or other type of retirement plan, it’s easy to forget all about it. But this is a missed opportunity to manage your investments for maximum return, Sanchez says.
“For a lot of people, this is where most of their savings is going,” he says. “Everyone should have an idea of what’s in their 401(k).”
At a minimum, find a target-date retirement fund that matches the date you want to retire. That fund is designed to maintain an investment mix that comes with an appropriate balance of risk and return as you age.
11. Abandoning your 401(k) when you switch jobs
When you move from one job to another, you take home the photos off your desk and your personal coffee mug. What you might not remember to take with you is your 401(k) savings.
You won’t lose the money in your old 401(k) if you leave it where it is, but you may be limiting your investment options. Sanchez suggests rolling the money into an IRA so you have more choices.
If you previously had an account administrator with high fees, look for an IRA rollover brokerage firm with lower fees.
12. Draining your 401(k)
Sweis cautions against taking a loan from an appreciating asset – such as your retirement savings – to invest in a depreciating asset, such as a car. You may never be able to replace the money, and that could put you behind your retirement savings goals later in life.
Instead, keep ample cash reserves in the bank to handle unexpected costs or big-ticket emergencies.
13. Not saving for emergencies
A February 2019 Bankrate survey found that only 44 percent of households have more money in emergency savings than the amount they owe in credit card debt. That’s down from 58 percent in 2018 and is a nine-year survey low. Sweis suggests having cash reserves equal to six months of your fixed living expenses, while other experts recommend a minimum of three months of living expenses.
Having cash reserves can keep you from dipping into your appreciating assets or going into debt when you hit a financial speed bump. If your car dies and you need to buy a new one, your cash reserves can save you from borrowing against your 401(k), racking up credit card debt or taking out a large loan.
When a life event drains your cash reserves, cut non-essential spending to free up money to put back into your emergency fund. You may consider temporarily reducing contributions for some investments to catch up on emergency savings, but try scaling back on unnecessary spending first.