Did you ever notice how some people, no matter how successful they are in their careers, always seem to have money problems? Then you look at an elderly person, who lives on a small pension and social security, (basically peanuts compared to the “successful” person above) and yet they always seem financially secure. (social security, for those of us who live in the US, although there are doubts that this will be around by the time, I’m eligible to receive it, but that’s a story for another time)
So, what’s going on?
Well, it’s pretty obvious with the modern mindset that most people regard money and finances a little different from a few generations ago.
Giving this dilemma some thought I came up with the top five reasons that seem to cause people to run into financial problems. These five actions can wreak havoc on your personal finances. Let’s identify and eliminate them. Then let’s go a little further and avoid getting into the mindset that causes you to accept making financial mistakes in the first place. This is the first step in taking back your finances.
Let’s create some financial health!
You goal HAS to be to get your personal financial position from the red (being strapped with debt) to the black (actually having a surplus of money each month).
Here is an article I wrote on creating a basic budget. I made it as simple as possible so everyone could be successful if they spent a little time preparing it. A budget is a great place to start building some financial health. Knowing what’s coming due ahead of time, so you can plan out each dollar makes it much easier to avoid falling into the five financial traps that I’ll outline next.
Remember no budget is perfect on the first pass, you’ll need to go back and refine it as new information becomes available (you get a raise at work and have more income to work with, buy a new home, switch insurance companies…etc.). Just take a stab at the first pass, it’ll be the most difficult, all other revisions will be a piece of cake.
Ok, without further ado, the five financial traps you must avoid.
Credit Cards are the Devil
I truly believe that if someone threw out all of their credit cards and pay for everything with cash it would eliminate 90% of the financial problems that plague people. (sure, there will always be that unexpected things that will throw some people into financial turmoil but for the vast majority, credit cards are root of all financial evil.
Having said that, I think it’s great that you can get miles, points or cash back when you use a credit card. Getting 1% cash back is a fantastic rate of return on things you have to pay for anyway (think: phone bills, cable bills, utilities, even groceries) plus any big item purchase (TV’s, furniture or vacations). A nice little “bonus” check or a free flight is absolutely great plus using a credit card is so much more convenient than carrying a wad of cash around.
Here’s the catch, here’s the golden rule that will make or break your finances (when using credit cards).
HAVE THE MONEY IN THE BANK TO PAY THE BILL BEFORE YOU CHARGE A CENT!!!
Doing this assures that when you get the bill at the end of the month you won’t have a problem paying it. You must psychologically earmark those funds for payment of the credit card. It’s a simple rule that hardly anyone follows anymore. (This is the primary reason I feel that the elderly person from a few generations ago, living on a meager pension, still is more financially secure than someone working for the big bucks. They don’t buy things they can’t pay for)
So for this to work you have to decide what kind of a spender you are.
Do you think of your credit limit on your credit card as cash you have available to spend? Or do you determine how much you have in the bank to pay for a purchase you are planning to make using a credit before you purchase anything?
That is the question.
Paying 18.99% on a purchase completely negates the 1% cash back in about 20 days. It’s never worth it.
There almost nothing I hate worse than making payments, I truly despise making car payments. I absolutely HATE and loathe the very existence of making lease payments.
Lease payments = car payments on ACID.
Because once you make the payment your money erodes into nothing. You get absolutely NOTHING to show for that payment, you aren’t getting any closer to owning the vehicle (at least with a car loan you will eventually own the car), furthermore you may end up owing for the privilege of “renting” the car (go over your allotted miles, little ding here or there, stain on the carpet…YIKES)
Leasing is like buying something you can’t afford. Sort of like buying something with a credit card that I don’t have the money for. For example, you lease a new Lexus for like $500 a month, with a couple thousand dollars down and you’re thinking “ok, I can afford $500 a month”. Now, if you purchased that same Lexus with the same two thousand down your payments would probably be double what the lease payments are.
So, if you thought $500 a month was doable, do you still feel that way at $1,000 a month? Most people can’t afford the cars they lease,
What’s the worst part of leasing? Perpetual Car Payments (PCP). You trade in the three year “old” Lexus put another $2,000 down and roll out with a new one (plus another 3 years of “rental” payments.
It’s a never-ending vicious cycle. (I’d rather buy that 3 year “old” Lexus that you just traded in, now that you paid like half the depreciation for me).
Failing To Save For Emergencies
When that unexpected thing happens, and it always seems to happen when you least expect it, having little or no emergency funds in place will turn a bump in the road into a 10-car pileup.
It’s quite alarming when you think about the saving habits of most people these days. I read recently that the average U.S. personal savings rates fell to ZERO (from 1%).
That is scary.
What is an emergency? There is always going to be a time when something will happen where you need money immediately (you were part the companies great new restructuring plan, you need a new roof, brakes for the car or your dog has bloat, and you need to decide within like 15 minutes whether or not to operate and save his life). For reasons like this we need an emergency fund in place.
What is NOT an emergency. That new outfit or car stereo that you “have” to have is not an emergency. A trip to Europe to see the Eifel Tower and Roman Coliseum is not an emergency. That 72″ plasma T.V…. You get the idea.
So how much should you save? What’s a reasonable amount to save in an emergency fund?
I recommend one year’s expenses. Now if you looked at my plan for making a budget you should have a pretty good idea about how much you need on a monthly, quarterly and annual basis for your expenses. Now look at the expenses and make sure there isn’t any “fluff” (yes, that’s a real financial term, I think)
See how much you need for the bare essentials each month (utilities, mortgage payments, groceries (NOT restaurants), cable, phone, gas for your car, car payment if you have them.
Say that’s $3,000 a month (or $36,000 year)
Now add any quarterly, semi-annual and annual payments into the equation. (property taxes, insurance) Say this comes out to 7,000 per year.
Add the annual and monthly expenses together and round up to the nearest $5,000 to arrive at the annual amount we’re going to use for our emergency fund.
$36,000 + 7,000 = $43,000 round up to $45,000
Whether you make $35,000 or $85,000 this is the number you should shoot for. This way you can be sure that at least you can cover a year’s worth of expenses or a pretty big emergency. (If you had to relief some of your emergency fund due to an actual emergency then you’d just start to build it back up until you hit the $45k, in this example)
How? I’ll discuss ideas for “how” at a later date, but here are a few tips to help you get started. How much does that coffee really cost?
Failing to Save For Retirement
As important as it is to save for an emergency, saving for retirement is another item that people don’t seem to grasp.
Here’s the paradox, most young people don’t see the need to start saving for retirement because they think that because they are young and have “so” much time before retirement that they can put off starting to save (or investing their own future).
The ironic thing is that money invested at when someone’s in their twenties will grow exponentially faster than money invested in someone’s fifties so the amount you would have to invest overall if you began younger would be a fraction of what you’d need to invest if starting when you’re older.
Does that mean you shouldn’t start investing if you’re in your fifties, absolutely not, you should absolutely invest for retirement no matter how old you are when you start. The only thing is that the older you start the more money you’ll need to invest.
So, start as young as you can – LIKE RIGHT NOW!
I’ll be talking about investing strategies in the near future to help pave a basic roadmap for your retirement savings.
Living Well Beyond Your Means
Another scary thought regarding the average savings rate being at about zero is that some people actually do save money, which means that some people are spending more than they make each year.
You have to make absolutely sure that you’re living below your means, this way there will be something left over for you to save (and not only for retirement or an emergency fund, but the European vacation fund, or the send my daughter to college fund, or the “I need that 72″ plasma T.V.” fund. You get the idea.)
Here’s the catch-22, by saving for things like retirement, emergency funds and vacations, it forces you to live below your means. Your saving part of your earnings so you have reduced the funds available to actually live on. If you amass retirement savings that allow you to replace 75% or your income, since you’ve been living on less than your total earnings, savings and budgeting, basically living below your means, you already used to living on this reduced amount.
On the contrary, if you never save, watch what you spend and live above your means (leased cars, credit cards with balances) you’re going to be in trouble when you want to retire or just want to work less. Your “above your means” lifestyle will be more difficult to maintain.
Temptations are everywhere these days, our brains are flooded with advertising, we want what our friends and neighbors have. It’s easy to get caught up in the “keeping up with the Jones” mentality. Let me offer you one more piece of advice that has helped me over the years.
Before buying anything ask yourself “Do I really need this?”. More often than not it’s a WANT to have rather than a NEED to have.
Let me know what you think, any questions, comments or suggestions?
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