Financial obstacles and distractions are inevitable, but here are some common personal finance pitfalls and practical tips for navigating past them so you can stay true to your long-term goals.
If your income rises and lenders are willing to offer you a large mortgage, it can be tempting to upgrade your house, or look at properties beyond your budget. However, taking on outsized housing costs could mean forgoing other financial goals or feeling financially pressured.
Tip: It’s commonly suggested that people spend no more than 28 to 30 percent of their gross income on housing. That benchmark can serve as a reminder that households have many expenses besides housing costs that need to be planned for. It’s important to also consider the costs of maintaining the house and whether the purchase will hinder your ability to meet other financial goals.
Without careful planning, a growing income can be swallowed by higher expenses. Lifestyle creep can occur unnoticed over time as spending that was once infrequent becomes a habit. This is reflected by a phenomenon psychologists call the “hedonic treadmill,” which describes the human tendency to adapt to our circumstances, coming to experience them as normal.1
Tip: Before you treat yourself, maybe recalculate how much you want to be saving long-term. Consider increasing the amount you put away to be on track to hit your short or long-term financial goals such as increasing your emergency fund or retirement savings.
It’s natural for parents to want to help their children with college, but tuition at public four-year institutions has more than tripled in the past 30 years.2 At the same time, Americans are living longer — the number of adults age 65 and older more than doubled from 1975 to 2015.3
While children can take out loans and apply for financial aid to help cover their school expenses, your options for funding your retirement will be much more limited if you prioritize college costs over your retirement saving.
Tip: Take advantage of any free match to a 401(k) provided by an employer to prioritize your retirement savings. Then, explore 529 plans, offered in most states, which provide tax benefits for college savings. Remember, you can help cover part or all of your child’s college expenses and debt if you have the extra income or savings beyond what is needed for your personal goals, but first, make sure it won’t affect your retirement planning and saving.
Your investment strategies will likely be different based on your age and your goals. Changing your investment strategy based on emotion can hurt your returns. Research shows that most investors who try to time the market in response to short-term swings do poorly, and their portfolios would have performed better if they had followed a consistent plan. Most investors won’t ever outperform an applicable index and the average investor usually lags behind an index by several percentage points. 4
Tip: Recognize that many people experience a psychological effect known as loss aversion: We tend to have stronger feelings about the risk of losing money than we do about the prospect of gaining it.5 This could make an investor over-invest or scale back their investments as markets rise or fall. Consider crafting a long-term strategy with a financial professional that you can stick to.
Some people start building a financial cushion early in their careers to help with unforeseen expenses or emergencies. However, as you start to accumulate wealth, the rising figure in your retirement account can make it seem less critical to keep short-term savings to cover an unexpected job loss or other changes to your income. But maintaining a fund that you can quickly access is still important.
Tip: The general rule of thumb is to have at least six months' worth of your household income set aside for unexpected expenses. If six months sounds intimidating, start with three months and grow your savings from there.
Investors can borrow money from their 401(k) accounts, whether to pay for children’s college tuition, buy a new house or car, or to cover emergency expenses.
While borrowers have a certain number of years to repay loans from their 401(k) accounts (total years will depend on your loan type), you’d be making loan payments in addition to new 401(k) contributions until you’ve repaid your loans. If you leave your company the loan must be paid off immediately. If you don’t pay it off, the loan will be considered a taxable distribution and possibly incur taxes and penalties.
Tip: Resist this temptation if you want to stay on track for your retirement. You will lose out on the benefit of compound interest, meaning it may be costlier — and sometimes unrealistic — to rebuild your retirement fund to the same level later.
Now that you know the common mistakes that can derail you from long-term financial success, you can make smarter decisions. Consider working with a financial professional to determine how to best meet your goals based on your personal circumstances. And remember to revisit your plan each year to make adjustments to changes along the way.
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