Would you prefer to listen to a podcast on this topic? Financial Beeswax’s Episode 10 discusses how to avoid financial pitfalls.
Many people find themselves experiencing the undesired effects of financial pitfalls. One way to avoid financial pitfalls is to know about them. This article certainly isn’t an exhaustive list, but it covers a lot of them.
Not Learning the Basics. I started learning about budgeting in my early 20’s out of desperation to get out of debt I had already acquired at a young age. My problem, though, was not learning other financial skills and terminology. I should have study financial concepts such as assets, equity, and liabilities on a personal financial statement, the different types of investments, the long list of financial terms, how to manage my credit report, along with other skills.
Thinking You’re an Expert. A surprising said a lot is, “I did a 12-week study (or read a book) on finance and I don’t need to learn anything else.” I am sure the 12-week was chocked full of valuable information, but I wouldn’t let a person fix my car, perform surgery on me, or advise me on childrearing after taking a 12-week study or reading one book. Would you? After reading one of Larry Burkett’s books on budgeting, I thought I was an expert. I realize many others have the same attitude. However, my journey of learning personal finance was just beginning. For the past seven years, I have been studying finance in college. The more I learn, the more I realize I do not know. Personal finance is a hefty subject. Don’t stop learning with one study, course, or book. Read several books a year and read all of the personal finance topics.
Focusing Only on Budgeting. Most material out there is aimed at helping others learn how to create and manage a budget. It makes sense as it is a foundational tool for effectively managing money. Creating a budget is easy, but managing one is difficult. Individuals need to understand more than how to create a budget. It’s important to understand what motivates a person’s financial habits; why they spend and save in the manner that they do. Many do not know the basics of balancing a budget, reconciling a checking account, how to use debt properly, how to fill out a personal financial statement and why that’s important, and so much more. Understanding the bigger financial picture in your life, leads to greater motivation to manage your budget effectively.
Ignoring Your Credit Report. A credit report is important and they are used for much more than obtaining a loan. A good FICO score on a credit report can lower auto insurance rates; lower or remove deposits for things like renting an apartment or getting utilities; make a person eligible for a good job; and much more. FICO scores use five variables, which can be understood reading What’s in my FICO Scores.
Using Debt Improperly. The phrase, “No one should take on any debt, period” is said a lot these days. To which I asked, “If no one takes on any debt, where will they live?” Did you think, “In an apartment?” That’s the answer most people give. However, an apartment lease is a debt. Most apartment leases require a year commitment. While an apartment lease is a short-term obligation, it is still a debt obligation. According to Here’s what the typical one-bedroom apartment costs in 50 US cities, the median lease rate for a one bedroom is $1,234.43. Rounding that median rent rate to $1,200 per month, an annual lease obligation for renting is $14,400. If a person defaults on their lease, they are still obligated to pay the remaining portion of their lease and any damages that occurred in the apartment while leasing it.
Many people take on too much debt. They let the creditor, which could be the loan originator at a financial institution or the apartment complex tell them how much they can afford. How much a person can manage to pay each month should be determined by the person obtaining the credit, not the creditor. Creditors use the gross income, not the net income when determining how much a person can pay. Since they do not know your net pay, you should determine how much you can pay and how much you are comfortable paying.
Lastly, it’s not uncommon for 20-somethings to have a lot of debt. According to Today’s 20-Somehting is Carrying an Average $45,000 in Debt, 20-year old’s are carrying debt between $12k and $78K of total debt. The reason I had debt at an early age was because I did not understand the basics of personal finance. Sure, I figured out budgets and how to manage one, but I did not understand the bigger picture of personal finances. I didn’t know how to manage a checking account or how to reconcile one. We need to start teaching our kids about personal finance at a young age and reinforcing it each year so they do not make the same mistakes about debt as seen in the article.
Avoiding Saving. Many may think that saving money is a common activity, but it isn’t. Statistically, most people do not have enough money in savings to pay for an emergency under $1,000. Opinions widely vary on the percentage a person should save, but one key thing to remember is that you should be saving as much, if not more, than you are giving. If you give ten percent away each month, make sure to save 10 percent each month.
Another important tip to savings is allocating jobs to your savings. Many do a good job at saving money only to spend most of it for unplanned, large purchases. Money in a savings account should be assigned various jobs. For example, you should determine how much is for retirement, vacation, house emergencies, college education, auto repairs, etc. Everyone has different purposes for their savings, but few allocated dollar amounts to those purposes.
Lastly, one financial pitfall that most people fall prey to, especially when they are younger, is not taking advantage of the free money offered by employers in a 401k match. Many companies offer matching an employee’s 401k contribution up to a certain percentage of their salary. Basically, this is free money. Sure, it means putting money into an investment tool that cannot be withdrawn before retirement with incurring penalties and fees, but it is money you wouldn’t otherwise obtain.
These are just a few of the financial pitfalls people experience as they management their money day-to-day. Below are some additional articles regarding financial pitfalls.
- Top 7 Most Common Financial Mistakes
- The Top Three Personal Financial Pitfalls to Avoid
- The Biggest Financial Pitfalls for Middle-Aged Adults
- How to Avoid 5 Financial Pitfalls in Your 20s