How to talk to your kids about money
Making the right money moves is a lifelong process if you want to achieve financial independence. Unfortunately, while it takes a lot of small, smart decisions to grow your wealth, it only takes a few mistakes to derail your efforts — potentially for decades to come.
The good news is that if you can avoid just five big mistakes, you’ll have a lot more spare cash — both now and in the future — to accomplish all of your important goals.
1. Waiting too long to start saving for retirement
The Center for Retirement Research at Boston College revealed in 2010 that just 60% of people in their 20s who were eligible to contribute to a 401(k) were doing so, compared with 84% of people in their 50s. Many young people either save nothing or save too little because they believe they have plenty of time, or because they have other demands on their cash and think they cannot afford to save.
Unfortunately, the longer you wait, the less the power of compounding will benefit you, and the harder it will be to save enough for a comfortable retirement. If you begin saving in your 20s, you could retire a millionaire by saving just over 13.5% of an average 20-year-old’s salary — even if you never increase your monthly retirement savings above $305 per month during your whole career. But if you wait until you’re in your 50s, you’ll need to save almost $4,000 a month to have $1 million by age 63, the average retirement age in the United States.
If you made the maximum IRA contributions of $5,500 starting at age 25 versus starting at age 40, you’d end up investing $82,500 more during your working years if you retires at 65. But the payoff of those early investments is enormous: Assuming your investments earned an average of 8% a year, you’d end up with more than $1.5 million in savings if you started at age 25, compared with around $435,000 if you began investing at 45.
2. Buying a home that is too expensive
Buying a home that’s too expensive makes you "house poor." You’ll pay more of your income than you should toward your housing, which will make it difficult to save or invest for retirement. A costlier home also comes with higher property taxes and insurance premiums. If your house costs more because it’s larger, you’ll spend more on furniture, utilities, and maintenance. Higher mortgage payments are also harder to make if you lose your job or otherwise suffer a drop in income, which makes the chance of foreclosure greater.
Most banks will only lend to you if your total debt, including all of your housing costs and other debts, amounts to 43% or less of your income. When considering only your housing costs, keep this number at or below 28% of your income. If housing is very expensive in your area, consider saving up for a larger down payment so your mortgage balance is lower — and avoid fancy mortgage products like balloon mortgages, which make a home seem affordable but could ultimately end up costing you the house if you cannot afford your payments through the life of the loan.
3. Leasing (or buying) a car you cannot comfortably afford
In the first quarter of 2016, 86.3% of new vehicles and 55.3% of used vehicles were financed. Just over 30% of new vehicles were leased. The average loan for a new vehicle was $30,032, and the average loan term for a new car was 68 months — more than five years!
A car or truck is a depreciating asset; it loses value continuously. When you finance or lease a car, you pay interest on a vehicle that is immediately worth less than you paid. Many people become trapped in a cycle where they buy a new car as soon as their old loan is paid off or go from one leased car to the next. If you do this, you’ll have car payments your entire life.
The average monthly loan payment of $503, or the average monthly lease payment of $406, could turn into $1.7 million or $1.4 million, respectively, if you invested these amounts monthly from age 25 to age 65 and earned an 8% return.
Is it worth $1.7 million for you to always have a new car? If not, keep your car as long as you can. Make "car payments" to yourself until you can buy an affordable, reliable vehicle by paying cash, and bank the money you save by not upgrading and financing vehicles every few years.
4. Buying depreciating assets on credit
Speaking of spending money on loans, are you among the 38.1% of households with credit card debt? If you’re buying items on credit — whether it’s groceries on a credit card or any other financed items — every dollar you’re paying in interest is making the financer wealthier and making you poorer.
The typical American pays more than $280,000 in interest over a lifetime. While much of this is due to mortgage debt, you could pay hundreds of dollars in annual interest costs on even a small credit card balance.
Borrowing money for a mortgage or an education makes sense, because your home will (hopefully) increase in value, and your education should increase your income. But paying interest on any purchase that isn’t necessary and won’t go up in value is a choice you’ll end up regretting.
If you can control your credit card use and pay your bills in full each month, then by all means, do so. It’ll keep your accounts active, which will bolster your credit score, and you may earn some rewards like cash back. However, if you can’t, make do with what you have until you’re able to pay cash.
5. Paying late on your debts
If you do go into debt, paying on time is essential. A single late payment could cause as much as a 110-point drop in your credit if you previously had a score above 780. Even people with a much lower 680 score could experience a hit of 60 to 80 points for being 30 days late paying a debt.
Bad credit will get you denied for loans, which could prevent you from buying a home and building equity (homeowners generally have a much higher net worth than renters). It could also mean paying thousands of dollars more in interest for a mortgage, a car loan, and other consumer debt. It could even mean higher auto insurance costs and the loss of some job opportunities — even prospective employers may check your credit score.
To make sure you don’t forget a payment, set up autopay and keep your borrowing to a minimum. The fewer monthly bills you must pay, the less likely it is you’ll slip up and fall behind.
By avoiding the other big mistakes on this list, you should have the cash to pay for what you need — and of course you’ll avoid car loans — so a late payment shouldn’t be something you’ll need to worry about anyway.