Mistake #1 – Buying a new car
I’ve bought two new cars in my life. And I’m still in my 20’s. The first was a 2012 Dodge Challenger. It was my reward for finishing college and securing a full time job after my internship went well. First mistake was selling my 2007 Honda Civic which had 105K miles but was still dependable. As I was still commuting to and from school/work (90 miles round trip daily) and would be for the foreseeable future, I should have kept the Civic and driven it into the ground. Instead, I blew my savings ($8K) and traded my Civic (Net +$5K) for the brand new Challenger. While I had a good down payment ($13K), I still had a car loan for $20K which resulted in monthly payments of $350. Not terrible. But I could have kept the Civic and my $8K of savings, and invested the savings into an Index fund. The unneeded car note could have been used to invest in funds monthly. After 2 years and 3 break downs later, I was forced to sell the Challenger. While I was able to trade it in for +$5K, I burned another $5K of my savings to buy a much more dependable, but more expensive 2014 Infiniti Q50. This new note resulted in monthly payments of $495 per month. As of this time writing this article, I’ve spent $13K on down payments for a new car, and have spent $38K on car payments in 7 years. I still have 1 more year of paying off the Infinity and by that time, I would have paid almost $45K in car payments in 8 years. Granted, I have a good paying job and still live with my parents. But I could’ve saved almost $60K (Not to mention capital gains from investing this money) if I would’ve kept the Civic and never pursued my desire for wanting a brand new fancy car. While it took me a few years to get this out of my system, I can proudly say I will never buy a new car again. According to NerdWallet.com, “The average person owns 13 cars in a lifetime, each costing an average of $30,000, according to a report by the National Automobile Dealers Association. If each of those cars was 3 years old, instead of new, you could save nearly $130,000 during your lifetime.” The reason for this is depreciation. As soon as you drive off of the car lot the car depreciates 10% in value. After 1 year of wear and tear it can depreciate up to 20%. A car loses its most due to depreciation in the first year. Now I’m not saying to buy a beat up car from the 90’s. But if you’re looking for a certain model, check into one that is 1-3 years older and has less than 30,000 miles. Any depreciation that you can save on is a plus. And for an added bonus, you tend to pay less in car insurance for used cars since they are not worth as much. Now you most likely will pay a higher interest rate on a used car, but the principal will be lower for a used car so most likely you will not be spending as much in interest. Let somebody else pay for your depreciation costs and buy used. It saves you money in insurance, down payments, and monthly notes. At the end of the day, all cars basically do the same thing. They get you from point A to point B. Do you really need all of the bells and whistles of a new car? I was so proud to buy those new cars and couldn’t wait to post pics on Instagram. It really is exciting to purchase a new car. Especially a muscle car or a luxurious one. But that excitement only lasts for so long and eventually it is just another car with its own set of problems. Save your money from buying used and use it on vacations, investments, paying off student loans, etc. My next car will either be a Toyota Camry or a Honda Civic, slightly used (1-3 years old, less than 30,000 miles). Both brands are reliable and retain their value more than other brands. Wisebread.com illustrates a great example of buying a car that is 1 year old and saving on depreciation costs. I also recently discovered a great website for purchasing used cars (Thanks to the How to Money Podcast) that I will seriously consider using in the future. And if you want to know what car you can afford, the 20-4-10 rule is a great one to live by.
Mistake #2 – Buying Whole Life Insurance
If I had to rank the financial mistakes I’ve made this would be one of the worst ones. For those that are unfamiliar with life insurance, there are two types, term and whole. Term life insurance is actually not bad. It is life insurance that pays a benefit in the event of the death of the insured during a specified term. It protects your dependents if you die prematurely and the premiums are relatively cheap. So say you take out a 20 year term policy at age 30. If you die before the age of 50, your beneficiaries receive the payout, tax free. Whole life on the other hand is the not so smart investment. Typically it’s pushed on you by a “financial adviser” (see mistake #3). Whole life insurance provides lifelong coverage and includes an investment component known as the policy’s cash value. This cash value grows VERY slowly. My financial adviser at the time sold me on this investment strategy for 2 reasons. One, I needed a guaranteed rate of return to balance my investments in stocks, Two, I could borrow money against the account at any time. However, a policy that’s held for 40 years or so will show a return of around 4%. A 4% rate of return is much lower than the average 7% rate of return of the stock market. And while you can “borrow” money against the account at any time, it comes at a price. You have to pay interest throughout the duration of the borrowing. Yes, you’re paying interest on your own money! Another downside to investing in whole life insurance is how slowly the cash value grows, which is illustrated in the table below. I started paying a monthly premium of $226 starting in October of 2013. By the time I came to my senses and surrendered my policy, I had paid over $12,000 in premiums. And yet my policy’s cash value at that time was only ~$2500! Essentially I lost almost $10k by cashing out. But by surrendering the policy now, I saved 36 years of premiums at a 4% rate of return. If I invested that same $226 monthly into Vanguard’s Total Stock Market Index Fund (VTSMX) over 36 years at the fund’s 9.74% rate of return (since inception), I would receive over $750K versus $200k. By taking a loss of $10K now, I make over $500K more in the future. So please don’t get suckered into buying whole life insurance like I did. Term is fine, just don’t buy whole. “Financial advisers” push this on you because they have a financial incentive to. Their commission can be up to 70% of the first year’s premium, followed by 3 to 5% per year as long as the policy remains in effect.
Mistake #3 – Hiring a financial adviser
One of the reasons why I built this website is that I don’t want you to make the same financial mistakes that I made. I want you to learn everything that I have learned about investing and managing your money. When I first hired a financial adviser back in 2013, I thought I was doing the smart, responsible thing. I thought I was financially ahead of most of my millennial peers. But as I learned more about investing and personal finance over the last couple of years, I realized that a financial adviser is not needed. Even though managing my money requires time, I enjoy it. And I don’t need someone to sell me products and services that are not appropriate for my situation just to increase their income. I also don’t need to pay them 1-2% of my earnings. I can just choose a traditional Vanguard index fund that has an average expense ratio of 0.74% or a Vanguard ETF that has an average expense ratio of 0.44% (expense ratio of a stock or asset fund is the total percentage of fund assets used for administrative, management, and all other expenses). For example, an index fund that has an expense ratio of 1% charges $10 in fees for every $1,000 invested in the fund. 1-2% may not seem like a lot but this can add up over time, considering missed appreciation, money lost to fees that do not grow and compound.
Mistake #4 – Investing in individual stocks
Back in 2015 I decided to try my luck with stocks and opened an eTrade account. I did NOT know what I was doing. I was mainly speculative buying. While I did pick some winners (Netflix, Apple, Square at its IPO), I also picked some real losers (GoPro, Twitter, Under Armour). Since then I have continued to sell off my individual stocks. They are just too risky and time consuming. Instead, I have chosen to invest some of my money in Vanguard index funds. Index funds are mutual funds or exchange-traded funds (ETFs) that closely track a target benchmark index. For example, you can buy an index fund that mimics the oil and gas industry, the technology industry, the US stock market, or the bond market. Index funds contain investment securities in the same proportion that they are represented by size in the stock market, so the largest company on the US stock market would also be the largest holding inside a US stock index fund. Index funds are managed by a fund manager that you pay a small fee to for his trouble of selecting the investments and managing the fund. Two of the biggest advantages in investing in index funds are the low fees and the broad diversification. Index funds can be made up of hundreds of holdings, therefore limiting your risk and increasing your exposure to the whole market. There are tons of index funds to choose from. Currently I’m invested in the following Vanguard index funds:
- Vanguard High Dividend Yield Index Fund (VHDYX) (0.15% expense ratio, 7.66% ROR since inception)
- Vanguard Real Estate Index Fund (VGSLX) (0.12% expense ratio, 10.25% ROR since inception)
- Vanguard Total Bond Market Index Fund (VBTLX) (0.05% expense ratio, 3.86% ROR since inception)
- Vanguard Total International Stock Market Index Fund (VGTSX) (0.17% expense ratio, 4.43% ROR since inception)
- Vanguard Total Stock Market Index Fund (VTSAX) (0.04% expense ratio, 6.61% ROR since inception)
- Vanguard Wellesley Income Fund (VWINX) (0.22% expense ratio, 9.65% ROR since inception)
In addition to the low fees and broad diversification, another sweet advantage to index funds is you just let them sit and grow and don’t have to worry about them. You’re not constantly checking your trading account every day and stressing out if a stock lost 3% in a day and debating whether to hold or sell so you can beat the market. I’m all for passive investing, and index funds require minimal time. One of the goals of investing is diversification and not putting all of your eggs in one basket. And index funds achieve this goal. Another added bonus to index funds is that most pay out dividends, either quarterly or monthly. These can be reinvested or paid out in cash. Check out WhiteCoatInvestor for a ton of portfolio ideas for investing in index funds.
Mistake #5 Not holding onto stocks long term
My biggest investing regret to this day was giving up on Netflix stock too soon. I had bought 10 shares in the summer of 2015 right before its 7 for 1 split. For those that don’t know what a stock split is, a stock split is when a company increases their number of shares that are outstanding by issuing more shares to their shareholders. For example, in a 7 for 1 stock split, seven shares are given for each share held by a shareholder. However, the stock price is also affected by a split. After a split, the stock price will be reduced since the number of shares outstanding has increased. So when I bought 10 shares of Netflix @ $700 per share, after the split I owned 70 shares @ $100 per share. My equity in the company did not change. I gained more shares but at a lower price. My reasoning for buying was that I wanted to capitalize on the split. Netflix was on the rise back in 2015 and I figured their stock price would head back towards $700 per share over time and I’d have more shares of it because of the split. I held onto the stock for a few months and being new at investing, I wasn’t comfortable with its volatility. At one point the stock had climbed to $130 and then had dropped to just above $90 in just a couple of months. Being a newbie, I panicked and sold and made a couple hundred bucks. But then Netflix took off in 2017 & 2018 reaching a high of $420! If I would’ve held on I would’ve quadrupled my investment and then some. To this day it makes me sick to my stomach. This happens to inexperienced investors and you learn from it. Warren Buffett has a great saying, “If you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes.” Now there will be instances where you can’t hold a stock for 10 years and you will want to sell and I’ll explain these scenarios in another post. But if you’re going to invest in individual stocks, please don’t make the same blunder I did. Buy a stock to hold onto long term. The stock market will experience swings. Stay focused on your goals and be patient.
Mistake #6 – Not maxing out contributions to Roth IRA
I was first introduced into Roth IRA’s by my financial adviser. He had to explain the concept to me a few times and honestly, I never completely understood IRAs until recently. While I was contributing a few bucks a month into the Roth IRA, I was never maxing it out. Which is quite dumb. Roth IRA’s are great retirement saving vehicles. Just like 401Ks, contributions are limited into Roth IRAs. As of 2019, you’re allowed to contribute up to $6000 yearly into a Roth IRA. And Roth IRA contributions are made with after tax dollars. So when you start making withdrawals from your Roth IRA account in retirement you owe nothing, not even for the earnings on your investments. With Roth IRAs, we’re given an opportunity to invest now and collect our earnings in the future without having to pay any capital gains tax. Everyone should take advantage of this opportunity and max out their Roth IRA contributions yearly. When you retire, you don’t want to pay taxes on every retirement account. Another HUGE advantage to Roth IRA’s are withdrawals. If you withdraw from a traditional retirement account before the withdrawal age (59 ½), you’re hit with a 10% penalty. But as long as you withdraw from your Roth IRA contributions and not earnings, it’s penalty free. So the Roth IRA essentially serves as an emergency fund as well. A third added bonus to the Roth IRA is that there is no required minimum distribution rule. For traditional retirement accounts, you’re required to start withdrawing from your account at the age of 70 ½. If not, you could be penalized a 50% fee on the amount you didn’t withdraw. But with a Roth IRA, there is no age you have to start withdrawing your money. You can let it sit for as long as you like. Now you’re probably asking yourself, how can I pay my bills, max out my 401K, and still have enough money to max out my Roth IRA? Here’s what I do. When I get my income tax return, it goes into the Roth IRA. If I receive any bonuses from work, it goes into the Roth IRA. If I win my fantasy football league (rarely), the winnings go into the Roth IRA. If I receive any dividends from my index funds or any investments, it goes into my Roth IRA. That way I’m never feeling it through my paychecks. The only downside to Roth IRA’s is there’s an earned income limit for contributions. As of 2019, if you’re single, your modified adjusted gross income must be under $137,000 to make contributions. Once you reach a gross income of $122,000, your contributions are reduced. If you’re married and filing jointly, your modified adjusted gross income must be under $203,000 to make contributions. Once you reach a gross income of $193,000, your contributions are reduced. RothIRA can explain in better detail for what the IRS deems earned income.
Now there is a way to get around the income limit for contributions and that’s called a backdoor Roth IRA. Simply put, if you make more than the income limit, and if you have a traditional IRA account, you can convert the traditional IRA to a Roth IRA. You can also roll as much money as you want from an existing traditional IRA into a Roth IRA. If the traditional IRA has more than the yearly contribution limits on Roth IRAs, you can roll over that larger sum into a Roth at one time. And you can only make one Roth IRA conversion per year. Keep in mind though, this isn’t a loop hole to avoid taxes. Uncle Sam wants his and will get it. If your traditional Roth account has all pre-tax dollars, you will have to pay tax on the entire amount you convert. If the traditional Roth has some pre-tax dollars and some that was already taxed in it, there is a pro-rata rule you will have to figure out to determine how much taxes you actually owe.
Mistake #7 – Contributing the minimum to 401K
You should always take advantage of a 401K employer match. That’s a given, it’s free money. If you don’t know, your employer will match whatever contribution you put towards your 401(k) up to a certain amount. So my employer does a 3% match. If I put 3% of my salary into my 401K, my employer will put that same amount into my 401K as well. You’re doubling your 401K contributions at half the cost. But you only get their money if you put yours in first. Which is what I did. But I never considered contributing more until I learned a couple of things. One, my supervisor told me that every time he received a raise, he increased his 401K contribution % to match that raise. So he never saw that raise reflected in his paycheck and didn’t need to. He was already living comfortably with what he was making before the raise. So I started to do that. And then I learned something very valuable. Something that should be common sense but I never thought of it this way. Increasing your 401K contributions to knock you down a tax bracket. Think about it. Your 401K is pre-taxed. The more you contribute, the less your taxable income is. So not only are you saving more for retirement by increasing your contributions, you’re also paying less in taxes because your taxable income is lower. Now I’m not a financial expert by any means, and not sure if experts would agree with me, but this is my approach now. I match my employer’s 401K contributions and contribute enough that reduces my tax bracket. Then I contribute the maximum of $6000 yearly to my Roth IRA. Then I go back and max out my 401K if I can ($19,000 yearly as of 2019). That way I’m getting free money from my employer (401K match), I’m maximizing my tax free income in retirement (Roth IRA), I’m reducing my current taxes (Increasing 401K contribution to reduce your taxes and knock you down a tax bracket if possible), and maxing out my 401K contributions to have more money for retirement.
Mistake #8 – Not keeping your savings in a high yield savings account
Ughh. Just another dumb thing I did. Keeping my savings in a traditional savings account. For the first 4 years working and saving for a house, I had all of my savings sitting in an account earning me pennies. The average interest rate on savings accounts is 0.08% APY (annual percentage yield), but many of the largest financial institutions in the U.S. pay as low as 0.01% APY. That’s criminal. If this is you, go find yourself a high yield savings account now. There are plenty to choose from. Ally, Barclay’s, Capital One 360, Synchrony. Doughroller and Nerdwallet already did your homework for you with their reviews and comparisons. All have interest rates of 2.00% APY and over. Some may require a minimal balance to receive the 2% like Capital One 360, which requires a balance of $10,000. Check out the links below and see what works for you. Almost all of these will be online banks with no physical locations. So you may want to keep your checking and savings at your traditional bank and then set up electronic transfers to your high yield savings account.
Mistake #9 – Not splitting 401K contributions between Traditional & Roth
Now this is one I just learned about. I know my employer offers traditional 401K and Roth 401k options, but I did not know you can divide your contributions among both. Currently I contribute to just the traditional 401K. After doing some research and talking to other colleagues, I learned that dividing my contributions among both 401Ks might be the better approach. Each option has its advantages and disadvantages. The money you contribute to a traditional 401K is not taxed at the time of contribution, but rather the contributions and earnings are taxed at the time you withdraw from the account. For 2019, the maximum amount an employee can contribute to their 401K is $19,000. If you’re 50 and older, you can contribute an additional $6000 annually into a traditional 401K (Catch-Up contribution). Employers typically offer to match a certain % for contributions. My work offers a 3% match so if I contribute 3% towards my 401K, they will also contribute 3% as well. The employer match does not count toward an employee’s contribution limit of $19,000 annually. However, there is a limit on total contributions from employer and employee. For 2019, the maximum allowable contribution to a 401K account, including employee contributions, as well as employer matching is $56,000, or 100% of employee compensation, whichever is lower. Now there are some downsides to a traditional 401K. You can’t withdraw from your account until you’re 59 ½ years of age unless you want to be hit with a 10% penalty, in addition to any income taxes you’ll have to pay as well. There’s also a Minimum Required Distribution Rule. Uncle Sam requires you to start withdrawing from your 401K on April 1st of the first year after either age 70 ½ or the year you retire, whichever is later. If you don’t, you will be hit with a 50% penalty on the portion you should have withdrawn. If you really need the money sooner and can’t wait until 59 ½, you can borrow up to $50,000 or 50% of the account balance, whichever is less. Typically you can only do this once a year. You will have to pay interest on the loan, but at least the interest goes back into your 401K account. If you fail to repay the loan, you could be hit with a 10% early withdrawal penalty. A Roth 410K is very similar to a traditional 401K in terms of contributions and penalties but the major difference is that contributions are made after taxes so when you withdraw from your Roth 401K, you do not pay taxes on contributions OR earnings. Earnings grow tax free. So when you’re trying to decide between a traditional and a Roth 401K, it really boils down to how much you think you’ll be paying in taxes when you retire. And when I say how much you’ll be paying in taxes when you retire, your tax rate is based upon how much you will withdraw (401K withdrawals are considered income) and not the tax bracket you were in the last year of employment before retirement. This is a common misconception. No one knows what the tax rates will be like in the future. Most likely they will be higher but who knows. Also, if you’re 20-30 years away from retirement, you may think you have an idea of how much income you will need to live on and the amount you’ll need to withdraw annually, but this is also a variable due to inflation. So if you think you’ll be in a higher tax bracket now than in the future, go with a traditional 401K. If you think you’ll be paying more in taxes in the future, go with a Roth 401K. Or you can hedge your bet and split your contribution equally among both types like I will. Keep in mind tho that if you have employer matching, the % that your employer contributes will go into a traditional 401K account, and not a Roth account.
Mistake #10 – Not contributing to an HSA (Health Savings Account)
For over 6 years of my employment, I never contributed to my HSA account. The only contributions were from my employer. I thought they were strictly used to pay for medical expenses and never gave it a second thought. But this is far from true. An HSA, Health Savings Account, is a tax-advantaged medical savings account that is available to individuals who are enrolled in a high-deductible health plan (HDHP). (For 2019, the IRS defines an HDHP for an individual as a plan with an out-of-pocket maximum of $6,750 and a minimum deductible of $1,350. For a family plan in 2019, the out-of-pocket maximum is $13,500 and the minimum deductible is $2,700.) They are designed to help individuals save for qualified medical expenses such as deductibles, copays, dental services, vision care, prescription drugs, etc. Just like a traditional 401K, the funds contributed to an HSA are not subject to federal income tax at the time of deposit. Contributions are made into the account by the individual or the individual’s employer and are limited to a maximum amount each year. In 2019, these limits are $3,500 for an individual and $7,000 for a family. If you’re 55 years or older you can contribute up to an additional $1,000. Contributions made by an employer to an HSA are included in these limits. You have to deduct what your employer is contributing from these limits and then what is left is the maximum amount you can contribute yourself. As previously discussed, contributions made to an HSA are 100% tax deductible and any interest earned in the account is tax free. (Watch out that you don’t contribute over the limit tho as this will lead to a 6% tax.) Most health insurance providers offer HSAs but if yours does not, you can open an HSA account at most financial institutions. In order to qualify for an HSA, the individual has to have a qualified HDHP, has no other health coverage, is not enrolled in Medicare and is not a dependent on someone else’s tax return. A great benefit to using an HSA is that contributions made to an HSA do not have to be used or withdrawn during the tax year. Any unused contributions can be rolled over to the following year. And if you should change jobs, you can keep your HSA. Once you’re over the age of 65 and enrolled in Medicare, you can no longer contribute to an HSA, but you can still use the money for out-of-pocket medical expenses. If you use the money on non-eligible expenses, you’re no longer hit with a penalty. You just have to pay income tax on that amount. If you’re under the age of 65 and use your HSA money for reasons other than paying for medical expenses, the amount withdrawn will be subject to both income tax and an additional 20% tax penalty. I had no idea that after the age of 65 you could use your HSA on anything and not incur a penalty. Think of an HSA as an extension of your traditional 401K, allowing you to make an additional contribution to annually. So instead of being able to only contribute $19,000 to your tax advantaged retirement account, you can contribute an additional $3,500 annually if you’re single or $7,000 annually if you have a family. And here’s the real kicker…. HSAs can be invested in mutual funds and stocks to generate more money! Typically HSA accounts require a certain amount before you can invest in mutual funds. For example, HSA Bank requires a minimum balance of $1000 to be able to invest and only the HSA funds above $1000 can be transferred from your HSA account to your investment account. So not only are HSAs a great way to save for medical expenses, but they can be used as another retirement savings vehicle that reduces your current taxable income at the same time.