When you look in the mirror, do you see an ally or an enemy? For many people, the person staring them back in the mirror is the number one reason for all their financial troubles but guess what, they don’t have to be. Knowing where you’re going wrong financially and what to do about it is the first step to starting a new chapter in your financial life and here are the biggest pitfalls you are going to want to sidestep to realize your own dream rich lifestyle!
Mistake #1: Mismanaging Debt
There are some pretty contentious subjects in the world of finance like cryptocurrencies and subprime loans however one topic that will be debated over forever is debt. For some, debt is the devil and for others debt is seen as just another tool in your financial toolbelt. In fact, you can liken debt to another tool we all regularly use which is a knife. When you use it properly, it can help you cut things faster but when you use it wrong it can leave you missing a finger or two — thankfully I don’t know this from personal experience!
So, like a knife, debt can be good or bad depending on how you use it. For instance, taking on high-interest debts to buy consumables or depreciating goods is never advisable. This is why you should be steering clear of both credit card debt and auto loans.
However, there are instances where taking on debt makes sense; think taking on a loan to cashflow your business or applying for a mortgage when you go to buy a home.
Whenever you take on any form of debt, two factors need to be in play. First, the interest on your debt must be low. Paying interest charges is the worst way to spend your money if you ask me so keeping these charges as a minimum is key. Second, you should only be using this debt to acquire appreciating or cash producing assets. This is why you see people take on mortgages, which is a form of debt, to buy rental properties that both make them money every month and appreciate over time.
Mistake #2: Overreaching On Your Home Purchase
Buying a home is the most life changing purchase of your life but not for the reason you think. I don’t mean it’s life changing because after buying a house you’ll wake up the next day as a new person. I mean the purchase of your home can either set you in the right or wrong financial direction for the foreseeable future!
For 99% of people, the purchase of their home is the biggest one they will ever make and this statistic is only getting stronger as home prices continue to soar. Unfortunately, these home prices are positively correlated with the rise of a home being a status symbol in the world we live in today. From what I see around me, owning a fancy home now carries the same status as owning a new sports car or a boat and this is a major issue.
As you have probably experienced yourself, people are going to judge you based on the size and appearance of your home — there’s really no getting around that in the world we live in today. Unfortunately, there are a lot of people who take this judgment extremely personally and as such will not accept buying a home that won’t impress their family and friends but doing so can cause a host of undesirable financial issues.
First of all, overextending on your home purchase is going to mean paying more interest on your home over the long-term. For instance, taking on a $500,000 mortgage versus a $300,000 mortgage at 5% over 25 years will have you paying over $150,000 more in interest over the course of your mortgage’s life. For most people that’s years of after-tax savings gone out the window for a home that was bought simply to appease the people around them.
Keep in mind, taking on more house than you need will also strain your monthly cash situation. A $500,000 mortgage will have you paying $2,900 in mortgage payments compared to $1,800 with a $300,000 mortgage. If you were to invest that difference for the course of a mortgage at the historical S&P 500 market return of 7% you’d have almost $900,000 and still have a house paid off as well!
Finally, if you do overbuy, chances are you are going to feel some mental repercussions as well. You probably won’t like it when all your friends are going on vacations or are having lavish weddings and due to your massive mortgage payments you can barely afford a night out at McDonalds. Therefore, do yourself a favour and always buy within your means.
Mistake #3: Not Starting
When I was back in high school, I hated homework. I’m sure that makes me no different than every other past and present student but the one saying that got me through all those grueling hours of readings and exercises was “the sooner you start, the sooner you’re done”. While the bulk of your studying days may be behind you, I have a feeling this saying could still be very useful in your own financial life.
I hate to say it but probably the biggest issue most people face when it comes to getting their finances in order is simply not starting. Their logical brain tells them that they should be paying down their debts, saving and investing but when push comes to shove, nothing gets done. It’s kind of similar to getting healthy. We all know that we should be working out and eating right but when that 5AM alarm goes off, not a single weight is lifted and the quest for better health is pushed off for one more day.
Similar to starting a fitness regime, delaying financial action will have more consequences on your future success than you think. First, it goes without saying that without starting, you’re never going to gain the experience and education you need to be good with money. No one starts off as a master investor and even people like Warren Buffett and Ray Dalio are constantly refining their skills to stay a cut above the rest.
Second, when you put off making any financial improvement in your life, you make starting a tad bit harder. This is because you allow hesitation to set in and cause the activation energy for the activity to increase. It’s kind of like how it’s easier to work out right as you get up because if you leave it until later in the day, the dread sets in and all of a sudden you’re “too busy” to get a good sweat on.
Finally, we can’t overlook the importance of time on your wealth building success. If you invested $500 a month from age 18–70, you’d have over $3M when all is said and done. If you wanted to reach this same investment figure and push off investing until 40, you’d have to contribute 5 times as much on a monthly basis or roughly $2,500. Therefore, unless you already have endless amounts of money then you’re going to want to have time on your side!
Mistake #4: Relying On A Single Source Of Income
If I had to guess, I would say that you parents wanted three things for you when you grew up. First, they wanted you to get a good education. Second, they wanted you to get a secure, well-paying job and finally they wanted you to find the partner of your dreams. Did I get it right? Well, I hate to break it to you but most people put way too much reliance on that piece of advice and this can result in terrible financial consequences over the course of their lives.
Now, you may be wondering, what’s wrong with getting a secure, high-paying job? Well, let me share with you another one of my favourite sayings which is “it’s all good until you get caught”. Kind of like when you and your friends thought it was cool to drive alone on your learners permit — everything was great until you saw those bright lights flashing behind you. Well, the same “oh shit” situation can happen to you if you don’t see past many of the flaws of relying solely on one single source of income.
The first reason you don’t want to rely on a sole source of income is because it will significantly hinder your financial progression. It’s kind of like the saying “two heads are better than one” well two income sources (or more) works in the same way. Chances are right now your current income progression model looks like this. You have a steady job, work hard and collect your standard 3–5% raise every year. A few times in your career, you will snag those more lucrative jumps in income when you get promoted. Otherwise your income growth is beholden to those annual raises. Is there anything wrong with this model? Yes, of course or else I wouldn’t have brought it up!
This method of generating more income fails in two regards. First, it takes your financial progress out of your hands and puts it into those who pay you. If you work for a great company with a promising future then sure things may work out but this is not going to be the case for everyone. As such, those raises you were expecting to keep you moving forward financially may come to a screeching halt and if that is the only way you are raising your income year over year then that is a major problem.
Second of all, the math doesn’t add up when it comes to getting ahead financially while employing this widespread income model. Sure, you may be collecting that 3% raise every year but for some reason bread, milk, gas and everything you routinely buy continues to increase in price as well. It’s at this point that you have to ask yourself if you only perceive yourself moving forward or if the math supports this reality.
The second major reason you need to develop additional income streams is that even in the most seemingly promising situations, your sole source of income is never guaranteed to be there. Case and point, the COVID-19 pandemic. 40% of low-income workers lost their job at some point during the crisis and if you think that your higher status position will save you, think again. Families making between $40,000 and $100,000 and $100,000 and above both saw job losses at a rate of 19% and 13% respectively.
Therefore, if you want to defend the integrity of your income and make meaningful progress in your financial life then building new streams of income is a no-brainer!
Mistake #5: Being Ignorant To Investing Fees
So you took my advice from mistake number 3 and started investing — well done! However, don’t lock in your retirement plans in Mexico just yet because there’s a culprit out there that is looking to push your timelines to sunny paradise.
If you’ve had your eye on the world of finance in the past year, you’ve probably come to notice that the general interest in investing and the stock market has been at new record highs and to me this is great. So many people have for years overlooked the power of investing and compound interest and are finally waking up to the realization that this is by far the most important tool they can use to build true financial wealth. However, many people fail to understand that part of this progress is being hindered by wealth crippling fees. For most people, their path to investing goes as such. First, they are either unaware of the benefits of investing or are too scared to get into the investing game. The second step is diving in and usually this takes place in the form of hiring an active money manager to handle all of their investing needs. Sadly, these individuals feel as if they are doing well by their finances and some are but most sadly aren’t and this is due to them subjecting themselves to exorbitantly high fees.
The average actively managed fund has an expense ratio of around 2.5%. That’s a small price to pay for someone to manage your money right? No, no it’s not. If you were to invest $1,000 a month for the next 30 years, you would end up handing over $500,000 in fees. If you can live off $50,000 a year in retirement, that’s 10 years worth of expenses you’re handing over to have someone manage your money.
But, at least the advisors who are collecting your half a million dollars are getting you superior performance right? Not quite.
Let’s take the Warren Buffett-Protégé Partners bet where the two sides bet $1 million on active versus passive funds to illustrate this point. The two sides bet that their investment choice would yield the greatest returns over the course of a 10-year period. Buffett selected the S&P 500 as his investment of choice whereas the Protégé Partners selected 5 actively managed hedge funds. The result? Even after a slow start due to the 2008 recession, Buffett and his index fund smoked the hedge funds by yielding a total return of 125.8% over ten years versus just 36% from the hand-selected hedge funds. And what is the cost of investing in the particular fund that allowed Buffett to win that bet? You can invest in this same fund for just 0.2%. Therefore, high cost doesn’t always mean high performance which is exactly why you can’t afford to remain ignorant to the investing fees you may be paying!