The first step in securing your financial future is to make a plan. But once you have a plan, or even if you are in the process of creating a plan, there are pitfalls that you must avoid. The following list is 11 common financial planning mistakes that many people make. If you’ve made these mistakes, don’t feel bad as many others have as well. If you haven’t made them, then take notes so you can avoid them.
Common Financial Planning Mistakes To Avoid
#1. Not Taking Action On The Plan
Sadly this is the most common financial planning mistake. You put all the time and effort into creating your plan and get excited thinking about your financial goals and dreams becoming a reality. Then you take a week off. That week turns into a month. Next thing you know, you have completely forgotten about your plan. Make sure you don’t stop once your plan is made.
#2. Not Having An Adequate Emergency Fund
Many experts recommend three to six months of living expenses in an emergency fund. Given the tough economy, I think your emergency fund should be closer to nine months worth of living expenses. Why? With such high unemployment, you never know when you may lose your job and you never know how long it may take you to find another one. It’s better to be safe than sorry.
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#3. Not Creating A Budget
I know, there isn’t anything fun when it comes to a budget, which makes this an easy financial planning mistake to make. Try to look at it not as a restriction of where you can spend your money, but a plan on where your money goes. With a budget, you know how much you spend eating out. If you are getting close to that figure, then you should make note of it. You don’t necessarily have to stop eating out for the rest of the month, but maybe cut back somewhere else, like clothing, if you still want to eat out.
A budget is like a relationship: it’s give and take. Overspend in one category and make sure you underspend in another.
#4. Not Paying Yourself First
Paying yourself first is the most important thing you must do if you want to be financially free. You should be doing this regardless where you are in your planning process. If you have a retirement plan through your company, then make sure you are contributing up to at least the match. Then, if you have direct deposit on your paycheck, you should set up an automatic transfer to have money taken from your checking account and transferred to your savings account every pay period. Or you could just sign up for Digit and be done with saving.
By doing this, you are certain to save money each month as opposed to spending everything and then complaining you don’t make enough money to save.
#5. Not Living Within Your Means
So many people spend more than they make. They try to keep up with others and while it may look like they are financially well off, in reality they are swimming in debt. Be happy with how much you earn and don’t overspend just to keep up. You’ll be happier and much better off in the end.
Additionally, as your pay increases, it is important to continue living as if you never received a pay increase. This is also known as lifestyle creep. As your pay increases, you buy a bigger house, a bigger or nicer car, more clothes, etc.
A pay increase is not an excuse to buy a new car. Your car needing more in repairs than it is worth is reason to buy a car. Make it a point to avoid spending more than you make.
#6. Investing Before Getting Debt Under Control
I’m not talking about all investing or all debt. Specifically, I am talking about taxable (non-retirement) investing and non-tax deductible debt (like credit cards). There is no point in investing and earning 6% when you are paying 18% interest on your credit card debt. Get a guaranteed 18% return on your money by paying off all of your credit card debt first. Then you can start concentrating on investing in non-retirement accounts.
#7. Having Consumer Debt
This goes along with the point above. If you have credit card debt and personal loans, you need to get to a place when you are not spending more than you make. There is no reason to have consumer debt. If you cannot pay for something in cash, then you cannot afford it.
#8. Paying Extra on Your Mortgage When You Have Consumer Debt
The recent trend is to own your home outright – to get rid of your mortgage. I am all for you paying off your mortgage. But many make the mistake of paying extra to your monthly mortgage payment instead of paying off your credit card debt first.
Most likely, your mortgage interest rate is 6% or less. This is before you take into account the tax-deductibility of the interest you pay. After this is factored in, your 6% interest rate mortgage is closer to 4%. Your credit card debt on the other hand is at 18% and you cannot deduct any of the interest on your taxes. Paying the higher interest rate debt first will help you to get to your financial goals quicker.
#9. Not Saving For Retirement
If you have a 401k plan through your employer and get a match, you need to invest at least that much in the plan. By getting a 3% match you are getting free money from your employer. Too many people pass this up. Once you invest to meet the match, you need to open a Roth IRA and save the maximum there. After that, increase your 401k contributions.
All of the money you save in retirement accounts is done at a tax advantage. You either avoid taxes on the money going into the account, or you avoid taxes on the money coming out depending on the type of retirement account you have. Make it point to save as much as you can for your retirement.
#10. Not Increasing Your Insurance Deductibles
When I set out on my own and had my own homeowners and auto insurance, I had a $500 deductible for the simple fact that I did not have much money saved up. Should something happen and I needed to file a claim, I could not have afforded to be out more than $500.
But once I built up my emergency fund, I increased my deductible to $1,000. Why? Because it lowered my annual premium. If I pay more out of pocket, my insurance premiums are lower. I am shifting some of the risk from the insurance company to me. This risk is minimal. Review your insurance coverage and increase your deductibles of they are less than $1,000.
#11. Not Having Umbrella Insurance
As you earn more money and increase your assets, it is important to protect them should a situation occur. By having an umbrella policy, you will have additional coverage on top of your auto and homeowners coverage.
Since most homeowners policies are limited to $500,000, you are on the hook should someone sue you for more. For example, let’s say you have $500,000 in homeowners coverage. A friend of your son comes over and slips on the sidewalk and breaks his neck. If they sue you and are awarded $1 million, you have to come up with $500,000. If you had an umbrella policy for $1 million, you wouldn’t owe anything.
The annual premium for umbrella coverage is not very expensive and should you have to use it, you will be grateful that you have it.
At the end of the day, these are the most common financial planning mistakes people make. I’ve made some as I am sure some of you reading this have as well. The goal is to learn from them so that we don’t repeat them again and again. Hopefully you haven’t made too many of these mistakes and now that you know them, can avoid them completely.
[Photo Credit: stevepb]