Proper planning is crucial when it comes to your finances -- not only for the decisions that can affect your wealth now but also for those that will influence your bottom line long term. But knowing how to make the best financial decisions isn't innate. And if you don't fully understand how to manage your finances, you're likely to make mistakes that can take your net worth from well-cushioned to barely getting by -- or force yourself to stay stuck in a constant financial struggle.
The good news is that the longer you have until your target retirement date, the easier it will be to recover from financial blunders, but what if you could avoid money pitfalls altogether? Take a look at these 10 mistakes that deplete your wealth so you can sidestep them and achieve personal financial freedom.
Last updated: Oct. 18, 2021
Brian Stivers, investment advisor and founder of Stivers Financial Services, said that one of the biggest mistakes that depletes wealth is investing in areas you have no experience in or don't truly understand.
"The media and internet are filled with fringe investments that promise great wealth with little risk," he said. "Yet, many of these are extremely aggressive and have a substantial downside. It is important for those who are accumulating wealth or have already accumulated wealth to make sure they fully understand the risk involved in any new investment and how that investment works. For most investors, it makes more sense to stay with traditional investment strategies that are easy to understand and have a long track record of success."
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Making Investments Based on Emotion
"Investing is emotional given the fact that money is at stake, but investors must control those emotions and aim to act on reason and rationality," said Jason Dall'Acqua, CFP(r) and president of Crest Wealth Advisors. "Unfortunately, people tend to make investment decisions that are against their own best interests strictly for emotional reasons. The most common example is chasing trends, which results in buying high or being panic-stricken during a market decline, which results in selling low. These decisions can have a significant negative impact on long-term investment returns."
Viewing Your Home as a Piggy Bank
"Too often, people take home equity loans when wanting to finance different objectives like purchasing a new car, making home improvements, paying off credit card debt or taking a vacation," said Robert R. Johnson, Ph.D., CFA and professor of finance at the Heider College of Business, Creighton University. "They constantly deplete the equity they have built up in their home and are unable to build true wealth."
Holding Unprofitable Investments
"One of the biggest wealth-depleting mistakes I see is people buying and holding investment properties that lose money or barely break even for the appreciation," said Cynthia Meyer, CFA(r), CFP(r), ChFC(r) with Real Life Planning. "The point of owning rental property is to earn net rents after expenses. If it costs you more every month to carry the investment than the net rent received, it's not profitable - and those accumulated losses may offset or exceed any potential price appreciation. What I always tell clients is that cash flow is the cake and appreciation is the frosting. You don't just eat frosting. You want cake with frosting."
Tapping Your Retirement Accounts Early
"It’s always tempting to think about tapping your retirement accounts for non-retirement expenses, such as paying off student loans, a new car, or other immediate cash needs," said Kenny Senour, CFP professional with Millennial Wealth Management. "However, it’s important to remember that the funds you are saving in those retirement accounts are meant to be long-term investments and grow over several decades with the market. On top of that, you are looking at some significant tax penalties for tapping your retirement savings early, which has the potential to derail your progress and set you back for years to come."
Not Having an Emergency Fund
"When we're doing well for ourselves in the moment, we might not be thinking of the possibility of an economic crisis like the pandemic or unexpected expenses like a car repair," said Katie Ross, executive vice president for American Consumer Credit Counseling. "But if you prioritize saving a part of each paycheck now, you'll thank yourself in the future. If you lose your job or have an ER bill to pay, you can lean on your emergency fund, rather than taking away from your living expenses to pay for it -- or worse, relying on credit cards or loans to pay and being in debt."
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Investing in Real Estate With a Short Time Horizon
"Some of the greatest depletions of wealth I've seen in working with clients is when they begin investing in real estate in the hopes of quickly turning a profit," Stivers said. "This is especially true in real estate markets, such as the one most of the country is currently experiencing with incredible appreciation trends. Real estate should be considered a long-term investment and not an investment to see great gains in a short period of time."
Becoming Too Conservative With Investments When Nearing Retirement
"Most people don't think of being too conservative as a risk to wealth, but it certainly can be, especially during the low-interest-rate environment we've been in for well over a decade," Stivers said. "Many people, as they near retirement, feel they have enough, so they move funds to CDs, high-yield savings or all low-yielding U.S. Treasuries. The net result is that they end up earning less than they are taking for retirement income and/or don't earn enough to keep up with inflation. So, they may protect themselves against market loss but still create a wealth-depleting portfolio through interest risk.
"I recommend my clients work with a financial advisor to help them create a portfolio that can protect their assets against market loss (risk management), have stable growth potential (investment management), have dependable income strategies (retirement income planning) and protect the spouse at the first death (legacy planning)."
Lack of Diversification Across Net Worth
"Diversification is very important, not only in investment accounts but also across varying asset classes," said Craig Borkovec, a financial advisor at Miracle Mile Advisors. "Many individuals believe they are investing through the real estate they own, the majority being their primary residence. This is not diversification from a wealth manager's perspective and has a high concentration risk to the real estate market. Diversification for wealth managers would include not only real estate but also investment assets in public markets and private markets or insurance policies to cover shortfalls in the event of death, disability or long-term care. These are a few ways to help diversify your overall net worth and minimize risk throughout your life."
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Expanding Your Business Too Quickly or Unnecessarily
"Many people accumulate wealth by starting small businesses," Stivers said. "As their businesses begin to grow and they begin to accumulate wealth, it is common that the desire to expand comes up. This may be opening additional locations, expanding product lines, hiring more staff, expanding infrastructure and a host of other expansions. This has been the number one reason I've seen business owner clients lose their wealth. The expansion comes at the wrong time economically, or they branch out into territory they don't fully understand. I recommend if the current business can grow incrementally and it is already providing wealth accumulation, that business owners consider being the best they can be in the current situation and to be satisfied with what they have."
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