If a fool and his money are soon parted, then it's only a matter of time before most people are broke. Especially if they're foolish and terrified of investing. One easy way to make sure you and your cash stay forever joined at the hip is to learn about the basic rookie investing mistakes other people make. That's why we spoke to Sophia Bera, a certified financial planner and founder of Gen Y Planning, to show us the pitfalls beginner investors fall into, and how you can avoid them.
Buying whole life insurance
Bera says she sees people falling into the trap of buying whole life insurance because there are legions of insurance agents hawking it as a safe investment (like a stock, many of these policies pay a dividend) and a way to get life insurance. That's a red flag. "Use investments for investments' sake, and use insurance for insurance's sake," she says. "Don’t try to do both with one product."
If you have a mortgage or some kids and want to protect yourself, the better move is to get term life insurance, she says. That way you don't have to pay such high premiums, and you can invest the money you're not throwing at an insurance policy into a retirement account like a Roth IRA or a 401k. Or you can invest it in a banana stand. We hear there's always money there.
Investing in the wrong places
Many companies offer to match dollar for dollar any money you put in a retirement account. Like a $20 bill you find on the street, that's free money. But unlike that $20, you won't be afraid to pocket this free money because it's not covered in blood and scribbles. Bera says if you're not taking full advantage of your company match (which sometimes can be worth thousands of dollars!), you shouldn't run to start a brokerage account. "Figuring out which type of account to invest in is more important than the investments in your account," she says. So put the stock trading on hold for a little and make sure your retirement account is full of cash.
Investing before you have a debt-repayment plan
Trying to make a killing in the stock market is a noble goal, but not if you have credit card and student-loan debt hanging around. “If you have debt that's more than 5% interest, I'm more of a fan of aggressively paying down that debt than investing,” Bera says. Credit cards often charge a 17% APR -- that's a pretty impressive rate of return you can guarantee yourself by paying it off every month. And the sooner you get it off the books, the better.
Investing money with a shady guy
Your money will buy him a helicopter -- which he will land in his yard -- and copious amounts of drugs. Because he's the kind of person who sees The Wolf of Wall Street as an inspirational tale, not a cautionary one.
Not knowing the tax implications of your investments
We've already established that investing in your 401k and your Roth IRA is a smart investment move, but it's important to know how your money is taxed in each account. If you are storing away a ton of money in your 401k, know that if you ever need to withdraw that cash before you retire, you'll be charged a 10% penalty, plus taxes on any gains -- to be fair, you'd be charged that even when you withdraw your money when you retire, too.
So if you contribute the max amount of $5,500 per year, and in five years it grows to $7,500, if you need the money, you can take out the original $5,500 without any penalty. “It’s like a backup, backup emergency fund for my clients,” she says. “That’s why I encourage people to put money towards the Roth IRA.”
Investing in crappy friends
Time is money, and investing time in certain friends could be costing you quite a bit. Especially if every time you go out with certain friends on the weekend, you spend a ton of money on dinner, drinks, or tickets to see Star Wars for six or seven shows because JJ isn't going to let us down! But yeah, with all those expenses, it's no wonder you're broke. Find friends that'll do free or low-cost stuff with you, and you'll have more money to invest.
Buying a home as an investment
A home might look like an investment, but it can get pricey, Bera says. “I'm anti-home-buying right now for a lot of millennials,” she says. “A lot of people value mobility over staying in one place. But if you get a job in another state and you have to move, what if it’s not the right time to sell your home? Then you’re going to rent it out, and you’re going to pay a property manager to rent your home. And if you sell, you’re going to have to [pay to] fix it up.”
Because people often like to buy new furniture for a new house or a remodeling job, Bera says they might be forced to dip into their emergency savings. And that's not ideal, as your emergency funds are for real times of need, and not just when you need to not have kitchen cabinets circa 1973 to put your feng shui in balance.
Not paying attention to fees
Buying mutual funds as part of your portfolio is great, but make sure you're not getting fleeced on the fees. Managed mutual funds (that is, those that have a "fund manager" choosing the stocks or bonds) have an “expense ratio usually around 1%.” This 1% will get in the way of you becoming a member of the 1%.
Some people believe that a good fund manager can outperform the stock market, and that paying the fee is worth it. Bera offers a counterpoint. “There’s a lot of mutual-fund managers that have underperformed,” she says. “They have good returns, and then they don’t. I’d rather just be tracking the index [Editor's Note: a selection of stocks like the S&P 500] and paying less fees.” For low-cost index funds, Vanguard has a good selection, and Morningstar can help you figure out how much you're paying on your existing funds.
Compound interest can be a beautiful thing. If you invest $100 and make 10% on that money in your first year, you have $110. Then if the next year you earn another 10%, you make $11. Your interest earned interest! Sadly, compound interest isn't all great if you have a bunch of student loans outstanding. “If you’re holding a ton of debt in your 20s and 30s, compound interest is working against you,” Bera says. “If you’re putting money into your 401k or Roth IRA, that’s compound interest working for you.”
But none of the good compound interest can happen if you don't start a retirement account and take advantage of your company match (assuming your company has that policy in place). Bera says you can set up an account easily in a few minutes online with Betterment too, if you want to invest in low-cost index funds. So get off your lazy ass and start investing or paying off that debt. Fallout 4 can wait. OK, it probably can't. Pause it, maybe?
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