Too much debt. Not enough savings. Investments that don't seem to make any sense. These are among the biggest money mistakes going — and, according to new research from Money magazine and Merrill Lynch Investment Managers, cost the average investor a quarter of a million dollars by the time they reach retirement.
And they are mistakes we keep on making.
In part, it's inertia. Starting to save and/or starting to invest means going to a bank, opening an account or at least picking up the phone. That can seem intimidating or too much of a hassle particularly when you have 17 other things on your to-do list. And it's also a fact that when you're using money to save, invest or pay down debt now, you're foregoing spending on other items that you may want. But you have to face up to just how much today's spending is costing you in terms of actual dollars later.
In some cases it is much, much more than a quarter-million dollars. In the work we did with Merrill Lynch — which involved an in-depth study of more than 1,000 individuals, so the numbers are very representative — we heard over and over again that people just don't realize, for example, when they pull a few thousand dollars out of a retirement account at a young age, that alone can be a six-figure dent in their retirement income down the road.
To help stop more of our hard-earned dollars disappearing into this unnecessary money pit, “Today” financial editor Jean Chatzky has a quiz to help reveal some of the mistakes we're making. Then she'll tell us how to fix them.
1: You see a great new mp3 player. You want it, and the price is right. But, you really can't afford it. Do you buy it anyway? YES.
2: Are there things you keep telling yourself you'll get to someday? Like put photos in an album? Make a will? Exercise?YES.
3: Do you tend to buy things on impulse, then regret it later? YES.
If you answered YES to Question 1, your money mistakes could be:
Too much credit card debtA recent Associated Press poll showed that half — half! — of all Americans are worried about the money they owe, which explains why for the third year in a row getting out of debt is the number one New Year's resolution. And the reason you need to get out of debt is that you have to do that before you can start saving or investing or doing any of the other things on this list.
The best way is to get on the “Pay It Down” plan we've been talking about for several months here on “Today.” If you can get yourself to put aside just $10 a day to put toward your debts, you can clear the average household debt of $8,000 in less than three years. Then you can use that $10 to start building your future.
Cashing out retirement accounts
Nearly half of all retirement plan participants who change jobs fail to roll over their accounts, according to Hewitt Associates, a human-resources consulting firm. Instead, they take the dough, incurring unnecessary taxes and penalties for doing so. And another 25 percent have outstanding loans or have taken withdrawals on the job.
What gives? Part of the answer lies in just how mobile the U.S. work force has become. The average worker changes jobs more than 10 times over a career, so the 401(k) balance from a single job often doesn't look like much. It's tough to envision that $5,000 or $10,000 might be worth $25,000 or $50,000 at retirement. But hey, it might make a nice down payment for a car right now.
The key to managing retirement assets is convincing yourself they are absolutely hands-off. If you need cash in a crunch, think about tapping a home-equity line of credit (or better yet, deferring that new-car purchase into 2006). And when you leave a job, pick up a rollover kit (nearly every broker has one). If you're too busy to bother with a rollover, and you have more than $5,000 in your previous employer's plan, leave the money where it is.
If you answered YES to question 2, your money mistakes could be:
Not saving enoughNearly half of those who took the Money/Merrill Lynch survey confessed that they had waited too long to start saving and investing, and more than a third said that when they did, they didn't put enough away.
And when you are talking about 401 (k)s, which often come with matching employer contributions, and IRAs, this is tantamount to throwing money away. Assuming an 8 percent return, every dollar put away at age 30 is worth more at retirement than $3 saved at age 50.
The government is doing its part — The 2001 tax law cleared the way for Americans to sock more in their 401(k)s each year through 2006. For 2005, the limit goes up to $14,000 per account holder (plus an additional $4,000 if you're 50 or over). IRA contribution limits also go up in 2005, to a maximum $4,000 (this year the $500 catch-up provision for those 50 or over remains the same).
Between your retirement plan at work, your IRAs and fully taxable investments, you should be putting aside at least 10 percent of your gross income (15 percent if you're over 50). If you're not anywhere near those savings targets, resolve to start somewhere in 2005. Begin with, say, 3 percent of your income. Then raise that figure by a percentage point on specific dates, like next Fourth of July and then the following Christmas.
Not rebalancing your 401(k) Once you have savings and investments, you need to make sure that they're properly allocated. That means that you have a mix of stocks (or stock funds), bonds (or bond funds) and cash that's neither too daring nor too conservative for a person with your goals at your stage of life. This is called your asset allocation.
And choosing that asset allocation may be the most important investment decision you'll make for 2005, so don't hesitate to seek advice. Many professional financial planners will help you set up a portfolio for an hourly fee. (For example, the fee-only planners in the Garrett Planning Network (garrettplanningnetwork.com) will work with you on an hourly basis or charge you by the plan.) If you'd rather do it yourself, we have a good asset allocator on www.money.com, the Web site for Money magazine. It requires only that you answer a few simple questions about your investing time frame and your appetite for risk, and then it tells you how to allocate your finances to better your chances of reaching your goals. And, if you already have an asset mix that makes sense for you, remember that market movements will favor one kind of asset over another and, in time, they will push things out of balance. So be sure to reset the mix periodically and rebalance as necessary.
If you answered YES to Question 3, your money mistakes could be:
Chasing what's hot We see our friends, colleagues and, worst of all, brothers-in-law making a bundle on a stock or a mutual fund, and we start to wonder why we should plod along with merely average investments. And daily newspapers and financial magazines will soon begin the ritual of listing the top-performing stocks and mutual funds of 2004.
Your first impulse may be to plow your money into the names at the top or follow your brother-in-law’s lead. Don't.
Many studies on the subject show that last year's top performers tend to be laggards within a few years. And you never know when the fall will start.
Too many eggs in one basketChasing hot investments often goes hand in hand with another big mistake: putting all our eggs in one basket. We tend to invest too much of our money in the stocks of our employers, the industry we work in or the company with a big operation close to our homes. We feel so sure of ourselves, we are so convinced we know what's right, that we figure that concentrating our investing in what we "know" gives us a better shot at striking it rich.
But it doesn't work when that investment tanks. And we've seen quite a few examples — Enron, WorldCom, etc. — over the past few years. To avoid the same fate, never hold more than 10 percent of your money in a single stock (or a mutual fund that holds only a small number of stocks), no matter how sure of it you think you are.
For more information on the research behind this article (and for a more in-depth quiz) go to hindsight2insight.com.
Jean Chatzky is the financial editor for “Today,” editor-at-large at Money magazine and the author of “Talking Money: Everything You Need to Know About Your Finances and Your Future.” Her latest book, "Pay It Down: From Debt to Wealth on $10 a Day," is now in bookstores. Copyright ©2005. For more information, go to her Web site, .