How to Avoid Making Financial Mistakes

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Personal finance is an important concept to master, not just for adults, but for young people, as well. If you don't fully understand how to manage your money, you could be at risk for making a number of common financial mistakes. We hope that by making you aware of these pitfalls, you'll be able to avoid them and live a financially fit lifestyle.

Financial mistake #1 - Living without a budget

We've mentioned budgeting several times before, and that's because it plays a crucial role in helping you manage your money responsibly. The good news about budgeting is that you can start practicing it early. The bad news is that it you may have to overcome your personal aversion to budgeting before you give it a try. That's a fairly common problem, probably because many people think that a budget will only shackle their lifestyle. Unfortunately, according to a 2013 study, only 32% of American households had a working budget in place. Every successful business has a budget that lays out its short- and long-term plans. Every household needs to do the same thing.

Learning how to create a budget may seem daunting, but it can easily be done in 4 steps:

  • Step 1: Estimate your monthly take-home income
  • Step 2: Estimate your monthly expenses/Create a journal
  • Step 3: Add up your income and expenses
  • Step 4: Save, Save, Save!

With a budget in place, you'll be able to improve your chances of achieving your goals because you'll be able to confirm how every single dollar you earn is being spent. Instead of losing track of $50 a week caving into mid-day cravings at the nearest fast food restaurant, or missing out on $100 dollars a month because you said yes to a few too many dinners out, you'll be able to contribute that money to a savings account, an emergency fund, or put it toward a larger financial goal, such as a new car or your first home.

Financial mistake #2 - Buying a house before you're ready

It's common and completely understandable to be excited about purchasing your very first home. Unfortunately, some people dive into homeownership before they're ready. Or worse, they buy more house than they can afford. Just because you're pre-approved to borrow a certain amount of money doesn't mean you should spend it all. Remember, you're committing to your house for 15-30 years. The larger and more expensive the house is, the greater the taxes and maintenance costs will be. Unless you have a large family, buying a big house at the top of your price range may simply guarantee that it will become a financial burden.

To figure out if your dream home will be too much to handle, follow this general rule of thumb: your total monthly debts (bills, expenses, mortgage, etc.) should never exceed 36% of your pre-tax income. Aside from the costs of living in your new home, you're also going to need to consider closing costs, moving expenses, any potential remodeling, and furnishing expenses. Your dream home may seem affordable at first, but it could end up being a nightmare for your bank account! Click to learn more about 1st-time homebuyer education courses.

Financial mistake #3 - Poor credit card habits

Many people begin using credit shortly after their eighteenth birthday. For college students, in particular, a credit card can be quite useful if they don't have the ability to work a full-time job while managing a heavy class load. Unfortunately, inexperience with credit can sometimes lead to the development of poor credit habits irresponsibility with credit, as well. Ordering pizza once or twice a week, shopping for clothes, buying gas for the car all small charges that someone with a full-time job could probably afford fairly easily, can quickly create a sizeable balance for a college student, whose part-time income keeps them from making more than minimum payments.

Credit cards are incredibly convenient there's no doubt about that, and they can help you gain access to more credit over time, but only when used responsibly. Overspending leads to big account balances and hefty monthly credit card payments. If you're unable to keep your balances down, your credit score will suffer, and you'll pay more for any additional credit you need. Instead of paying the minimum each month, pay as much as you can. Paying down your debts quickly is the key to avoiding added interest or late fees.

Financial mistake #4 - Living paycheck-to-paycheck

In the 2014 Federal Reserve Consumers and Mobile Financial Services Report, participants were asked if they, their spouse or their partner, had ever held a savings, checking, or money-market account at a bank or credit union. Only 37.2% of respondents said yes. Nearly 25% indicated that they didn't have enough money in order to maintain a minimum account balance.

Living paycheck-to-paycheck is almost always an unsustainable proposition, and it's actually quite dangerous. If you're using your entire paycheck in order to pay your bills and purchase essentials, you're running a serious risk of financial ruin. Even a minor car accident or medical bill could throw your entire life into a tailspin.

If you don't have a bank account or you're barely able to maintain a minimum balance, we suggest that you begin journalizing your expenses for a month and see where your money is really going. You may be able to identify some expenses that you could reduce or eliminate entirely. Take a look at our Creating a Crisis Budget article to learn more. While you may not consider your situation critical, it won't hurt to create a plan that will help you get to a safer place financially.

Financial mistake #5 - Not saving enough for retirement

You may think you don't have time to think about retirement, but you have to plan for it. The best thing you can do is to start saving for your retirement as soon as you can. The earlier you start saving, the sooner your money will start collecting interest, and the better off you'll be financially in your golden years.

There are a number of questions you should seriously consider as you start your retirement planning, because your answers will determine how much you'll need to save to make the life you envision possible. For example: will you and your spouse retire at the same time? Will you travel during your retirement to visit your grandchildren or see the world? Will you need to buy another car during retirement? What home maintenance projects (e.g., a new roof or driveway) will need to be performed during those years? What new expenses, such as medications, nursing home or hospice care, will become part of your budget? It's difficult to create a savings plan unless you try to calculate how much you'll need. To that end, most experts agree that you'll need 70% of what you earn in an average year for every year you live in retirement (And that's a conservative estimate.)

For example, if a couple has a combined income of $70,000 per year, statistics show that they're going to need roughly $49,000 per year for every year they're retired, just to maintain their current lifestyle. That may be as much an indicator of how wedded we become to our lifestyle as it is revealing about how resistant we are to cutting back on expenses. Either way, however, knowing how difficult it is to change our spending habits in retirement should make all of us more serious about saving for it today.