7 Costly Money Mistakes and How to Avoid Them

Smart and easy ways to manage your finances, save money and invest more effectively

Greg Daugherty Money (January 14, 2015)

Managing our money isn’t only about doing the right things. It’s just as important not to do the wrong ones. From passing on “free money” in our 401(k) plans to paying too much in investment fees, here are seven money mistakes that many of us make but could easily avoid. Are you making any of these financial flubs? 

1. Missing out on 401(k) benefits

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If you work for a company that offers a 401(k) or similar retirement plan, it’s a mistake not to take advantage of it, even if your retirement is decades away. You’ll be saving toward a more comfortable retirement, and any income you contribute will come out of your paycheck untaxed, though you will owe tax when you withdraw the money after you retire. Many employers will match a portion of your contributions, such as $1 for every $1 you contribute, up to a certain percentage of your salary. That, notes Michael Terry, a certified financial planner in Maspeth, New York, is “free money.”

How to avoid it: Many financial planners recommend contributing at least enough of your salary to your 401(k) to get the full employer match. If you can afford to kick in more than that, you’ll be doing your future retired self a favor. For 2015, you can contribute up to $18,000 if you’re under age 50 or $23,500 if you’re 50 or over. 

2. Looking forward to a big tax refund

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Nearly three-quarters of Americans receive a tax refund every year, with a current average of $2,744. That might seem like a reason to celebrate, but most financial planners will tell you it’s not. By having more dollars than necessary withdrawn from your paycheck, you’re losing the use of that money and the interest it could earn if you invested it.

How to avoid it: Fill out a new Form W-4 at work,adjusting your withholding so that it’s more in line with the amount of income tax you expect to pay for the year. If your financial situation hasn’t changed much, last year’s tax return could be a good guide. But if you overdo it and have too little withheld, you may be subject to a penalty for underpayment

3. Focusing only on the small stuff

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Clipping coupons and watching for sales at stores are fine ways to stretch your household budget. But you can probably save a lot more by focusing on your biggest bills instead. For most of us, housing and insurance will be near the top of that list.

How to avoid it: If you have a mortgage, check the latest rates on websites like BankRate.com or HSH.com. If the rate you’re paying is substantially higher than you could get elsewhere, it may make sense to refinance. Though you will face some upfront costs, the long-term savings could be substantial. For example, trading a $100,000, 30-year fixed-rate mortgage at 6 percent for one charging 4 percent could save you $120 a month and nearly $44,000 over the life of the loan.

As for insurance, rather than automatically renewing your policies every year, take a moment to check the premiums you pay against what other companies are currently charging for similar coverage. A 2014 J.D. Power study found that customers who changed their auto insurers saved an average of $300, and the longer they had been with their current insurer the more they saved by switching. 

4. Failing to diversify

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Putting your money into a variety of investments is far safer than putting all your eggs in one basket. Investments such as stocks, bonds and real estate can perform differently depending on what’s going in the economy. For example, when stocks are rising in value, bonds may be falling, and vice versa. A diversified portfolio gives you some protection against big losses, especially at a time when you might need the money for other purposes, such as putting a down payment on a home or sending a child to college.

How to avoid it: Read up on diversification and asset allocation.There is a lot of good, basic advice online. Consulting a financial planner could also be helpful.

Also take a close look at the investments in your 401(k) plan. If you’re like many people, a substantial portion of your money may be in the stock of your employer. That’s doubly risky: If the company gets into financial trouble, both your job and your retirement savings could be in jeopardy. Most experts suggest investing no more than 10 to 20 percent of your money in employer stock. 

5. Ignoring investment fees

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They seem innocent enough—1 percent here, 2 percent there—but over time, the fees we pay on investments like mutual funds can take a serious bite out of our savings. The Securities and Exchange Commission gives an example of investing $100,000 for a period of 20 years. If the money earns 4 percent a year on average, an investment with annual fees of 1 percent will be worth about $180,000 at the end of that period, while one with fees of 0.25 percent will be worth nearly $210,000—a $30,000 difference.

How to avoid it: Before you invest in anything, ask what fees you’ll have to pay. Some investments not only have ongoing annual fees but additional charges when you buy or sell. Mutual funds are required to disclose their fees and other information in the fund’s prospectus. Because these documents must follow a standard format, it’s easy to compare one fund’s expenses against another’s. They’re often available online as well as in paper form. 

6. Overestimating potential returns

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Stocks had a pretty good year in 2014, gaining more than 11 percent as measured by the S&P 500, one widely used market index. The previous year was even better, with the S&P 500 up nearly 30 percent. But it’s a mistake to believe that returns like that will go on forever or to make any long-range financial plans based on overly rosy assumptions. In 2008, for example, the S&P 500 lost more than 38 percent.

How to avoid it: Markets have great years and gruesome ones, so figure that your results will fall somewhere in between. What’s a reasonable rate to count on? Financial planner Terry says, “A good, balanced portfolio should average around 6 to 8 percent a year over time frames of five or more years.” A “balanced” portfolio means one that contains both stocks and bonds, in a ratio appropriate for your age (more stocks when you’re younger, more bonds as you get older). 

7. Procrastinating on your will

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Only about 44 percent of Americans currently have a will, according to a 2011 survey. For many of us, that could be the biggest financial mistake of all. Even if you’re far from rich, a will can ensure your money and possessions go to the people or charities you want to receive them if you die. Otherwise a court will make that decision. If you have minor children, it’s also where you name a guardian for them should something happen to you. If you don’t have a will, a court will decide that too.

How to avoid it: Many lawyers can draft a will for you. You can also prepare one yourself, using software or blank forms available at many stationery stores. 

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