4 Most Common Financial Mistakes and How To Avoid Them, According to Experts #NewsUnitedStates

Money comes, and money goes. This might be true, but if you are seeing more of your money go away from you than come to you, chances are you’ve got some problems lurking beneath the surface.

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Everyone makes mistakes with their finances at some point in their lives — that’s okay, because it’s how we learn and grow. However, there are some common financial mistakes that you might not be aware of and could be making without even knowing it.

GOBankingRates decided to put the call out to some experts on the matter and got insight from Robert R. Johnson, a chartered financial analyst (CFA) and a professor of finance at Heider College of Business at Creighton University. Here’s what he said are the most common financial mistakes and how to avoid them.

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Buying as Much House as You Can ‘Afford’

According to Johnson, being “affordable” means different things to different people.

“Too often people make the mistake of spending too much of their income on a house and effectively ‘crowding out’ other investment opportunities,” he said.

Johnson recalled that in 2013, Robert Shiller, the winner of the Nobel Prize for Economics, was on Bloomberg talking about residential real estate as an investment.

Shiller said, “Housing is traditionally not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. And there’s technical progress in housing. So, the new ones are better …

“So, why was it considered an investment? That was a fad. That was an idea that took hold in the early 2000’s. And I don’t expect it to come back. Not with the same force. So, people might just decide, ‘yeah, I’ll diversify my portfolio. I’ll live in a rental.’ That is a very sensible thing for many people to do.”

Johnson agreed with Shiller.

“Many people mistakenly believe that real estate is a good and safe investment,” said Johnson. “They fall prey to stories of [real estate] values rising dramatically over long periods of time. What they don’t realize is that from 1890 to 1990 the inflation-adjusted appreciation in U.S. housing was just about zero.

“That amazes people, but it shouldn’t be so amazing because the cost of construction and labor has been going down. The decision to buy or rent a home is essentially a financing decision. By over-investing in real estate, many individuals ‘crowd out’ other investment opportunities — like investing in stocks and bonds,” he said.

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Johnson’s advice is to not succumb to the advice of mortgage bankers who will tell you based on your income how much house you can afford.

“Procure the house that you need, not the most expensive house you ‘can afford,’” said Johnson.

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Succumbing To Lifestyle Creep

Another mistake Johnson noted is letting your spending increase when your income increases.

“For instance, people move into a bigger apartment or buy a more expensive car or home to reward themselves for receiving the raise,” explained Johonson. “What happens is they are unable to improve their financial condition because they spend everything they make.”

He continued, “… to effectively invest any money from a raise is to act as if you didn’t receive the raise. That is, continue to live the same lifestyle you led before receiving a raise and invest the difference.”

To illustrate his point, Johnson gave the following example: “Suppose one receives a $5,000 annual raise early in one’s career. If you simply invest that $5,000 annually into an investment account growing at a 10% annual rate, you will have accumulated over $822,000 in 30 years. You will have invested a total of $150,000 and have earned $672,000 from those investments.

“And, lest you believe that a 10% average annual return is unrealistic, according to Ibbotson Associates, since 1926 the average annual return on a large capitalization stock index (think S&P 500) is 10.3%, while investments in long-term government and long-term corporate bonds have on average grown annually by 5.7% and 6.2%, respectively,” said Johnson.

He added that people should listen to Warren Buffett’s sage words: “Do not save what is left after spending; instead, spend what is left after saving.”

Not Taking Enough Financial Risks

“Financial mistakes begin early in life, and the biggest financial mistake people make is taking too little risk, not too much risk,” said Johnson. “Unfortunately, many people allocate retirement savings to money market accounts or low-risk bonds.”

Above, Johnson pointed out how large capitalization stocks (like the S&P 500) returned 10.3% compounded annually from 1926-2023.

“Over that same time period, long-term government bonds returned 5.1% annually and t-bills returned 3.1% annually,” said Johnson.

“The surest way to build wealth over long time horizons is to invest in a diversified portfolio of common stocks. Someone with a long time horizon should not have exposure to money market instruments, yet many investors do because they fear the volatility of the stock market,” he added.

Early in their working lives, Johnson recommends people begin investing in a low-fee, diversified equity index fund and continue to invest consistently whether the market is up, down or sideways.

Dollar-cost averaging into an index mutual fund or ETF is a terrific lifelong strategy. Savvy investors should be 100% invested in stocks and have no bond exposure.

Not Taking Full Advantage of Tax-Sheltered Savings

In Johnson’s professional opinion, one of the most important financial decisions anyone makes in their life is the decision to participate in an employer-sponsored retirement plan.

“Perhaps the worst financial mistake anyone can make is turning down free money,” said Johnson. “If one does not contribute enough to a 401k plan that has a company match to earn that match, one is basically turning down free money.”

While many people struggle to participate in their company’s 401(k) plan because they’re prioritizing paying down debt or buying a home, Johnson urged people to do whatever it takes to get the full employer match.

“The opportunity loss of not electing to participate in an employer matching program is substantial,” he continued. “If you have a 100% employer matching program, you are essentially electing to turn down the equivalent of 100% of what your own contributions would grow to.”

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