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Five years ago you probably told yourself that five years from now, you would be substantially wealthier. Are you? For those of you who are, congratulations, you are probably more disciplined than most. For the rest of us… well, we are human, and we err.
It actually turns out that most of us err in very similar ways though, which means there are just a handful of roadblocks that are getting in the way of most Americans’ and Canadians’ financial goals. Here are the three most common missteps that North Americans make on the road to financial independence, and they all reinforce each other for either a downward plunge or fast ascent.
1. We Spend Too Much
Over half (52%) of Americans reported in a recent survey by Country Financial that they spent more than they earned at least a few months out of the year, yet only 10% admitted their lifestyle overspent their means. A “normal” savings rate is 10% of after-tax earnings, but normal will not get you anywhere fast, so consider 25% instead. The average U.S. savings rate? Currently it sits at a disheartening 4.9%, down from 14.6% in 1975.
If possible, have savings automatically pulled from your paycheck before it even gets to your checking account, to remove even the option of spending it. If that is not possible, set up automatic transfers of money from your checking account on the day you get paid every pay cycle, so the money instantly goes to a difficult-to-access savings account before you can spend it. Another possibility is having money automatically invested in retirement accounts, which brings us to…
2. We Pass Up Free Money & Discounts
Americans can pay up to $17,500 into retirement savings every year tax-free, through a 401(k), and can even invest in rental properties and other real estate with their 401(k). Assuming a 30% tax rate, that represents $5,250 that you may be paying in unnecessary taxes every year. But the greater loss is the missed savings and lost returns on that money.
Further, some employers offer optional benefits, such as health care and retirement contributions, but only if the employee also contributes a certain amount themselves. This is free money left on the table by many Americans and Canadians.
And then there are the unused credit card rewards, the other tax breaks we fail to take advantage of, the things we buy new that we could buy used for half the price, and so on. A pattern should be emerging by now: because we spend too much, we have less money for investing, less money for capitalizing on employer- and tax incentives, and…
3. We Owe Too Much in Debts (and Interest Payments)
Credit cards and personal loans are the big offenders here – according to Nerdwallet.com, the average U.S. household carries $7,281 in credit card debt alone (the number jumps to $15,607 if you exclude households with no credit card debt). Credit cards have notoriously high interest rates, often in the 18-24% range, which can become crippling quickly. Credit card companies encourage you to maintain high balances by making the minimum payments very low, so that it would literally take nearly three decades to pay off that average credit card of $7,281 if only the minimum payment were made.
Before you consider investing in anything, be it real estate, stocks, bonds or anything else, start by paying off your credit card balance and any other personal unsecured debts. Carrying debt at 20%, while investing money in stocks or rental properties at a return of 7%, you still lose a net 13% on the money in question. Pay the debts first, then continue saving at the same rate you had been paying down debt, and suddenly you could go from losing 20% in interest to gaining 7-10% (or more) in returns.
The keystone to most of our finances is spending. If you spend less, you can avoid personal debts like credit card balances and personal loans. You can take advantage of employer- and tax incentives to invest more money in retirement while spending less in taxes, health care, etc. You can invest more in income-producing assets, such as dividend-paying stocks, high-yield bonds and rental real estate. With the income from these, you can invest even more, and the snowball builds wealth, rather than tumbling on a downward spiral of debt.
Related Reading:
Is It Ever Worth Borrowing from Your 401(k) or IRA to Buy Real Estate?
Case Study: How I Earned a 29% ROI on a Deal I Found on the MLS
The 25X Rule for Retiring Early (…and How Rental Properties Change the Math)
