Financial decision making is very important part of our life. These are 11 things that most people get wrong about money. And since we have 11 of them, which is a lot of anything to have, Iâm going to get right into it.Â
1. Putting money into a retirement account
Just putting money into a retirement account doesnât mean youâre investing. Contributing to an employer-sponsored plan like 401(k) or 403(b), an Individual Retirement Account, also called an IRA, or another retirement vehicle is a great start. But something that many people donât understand is that these are just the accounts that hold investments. A 401(k) or an IRA is not itself an investment. That means that you actually have to invest the money you put into an account in order to eventually earn interest, which is the entire point of investing. According to a poll from ValuePenguin in CNBC Make It, nearly two-thirds of Americans donât understand how a 401(k) works. Your company plan may already select investments for you, but that doesnât necessarily mean that youâre locked into what they choose. Just do some basic research. Our resident investing expert Amanda Holden has some great resources. And you certainly donât have to be an investing expert to make the most of 401(k) or IRA. There are even robo advisors that can do the work for you. But you have to make sure that the money thatâs in there is actually being invested.Â
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2. You can be financially independent even if you donât own a home
So first of all, we did an entire video on how renting can often be better than owning, so start by watching that. Itâs linked in the description. But generally, in America, homeownership has been viewed as the only smart thing to do financially, and renting is always, quote/unquote, throwing your money away, which is a phrase I just hate. Now, homes, on average, do tend to appreciate in value, which means that generally speaking, if you stay in a home long enough, you can expect it to sell it for more than you bought it for. But especially with the extra costs of homeownership that come in addition to a mortgage, renting is often much more financially feasible. Many people have relied on selling their homes to finance things like retirement. But your return on investment is not a given. And real estate is hardly the only way that you can invest. Financial independence means not needing income and employment in order to live. And you can achieve this even as a renter. As CNBC put it, historically, the stock market has better returns than real estate. Quote, From March 1992 through September of 2022, home prices have logged an average annual growth of 5.3%, according to data from research firm CIC. Over the same period, the S&P 500 posted an annualized total return of 9.5%. In general, while buying homes on average is in the longer term a good investment, you need to make sure that it is the right investment for you at the right time because buying into the wrong home or at the wrong time can be financially devastating. So again, I highly encourage you to check out our video all about the differences between when itâs good to rent versus buy.
3. Savings should be something you do passively, not actively
So when people think of saving money, they often picture the act of physicallyâ well, I guess, not physicallyâ but actively taking money from a checking account and putting it into a savings account. But that is actually the absolute wrong way to do it for very real psychological reasons. Studies show that people are much more likely to save when it is a passive thing that happens automatically from their paycheck, and they donât have to think about where that money is being allocated. Not only are you liable to forget, if you have to move the money, but youâre also liable to look at that amount of money and be like, well, damn. I donât want to put this into some boring savings account. I want to do something fun with it. Plus, you feel the punch of having to see that money disappear. Whereas if itâs automatically deducted from a paycheck, you never counted it in the first place. And if youâre a freelancer or otherwise have inconsistent income, there are many online-only banks that work well for your situation. Capital, for instance, will allow you to create a rule to deposit a set percentage of every deposit from your checking account to go directly to savings.Â
4. Investing should not mean picking individual stockÂ
When many people think of investing in the stock market, they think of owning individual stocks of big companies that most of us have heard of. But stock picking is only one way to invest, and the rewards often donât outweigh the risks because most investors just donât beat the market. Hereâs some data collected by JPMorgan on average returns from 2001 to 2020. The S&P 500 had an average annual return of 7.5%. A basic portfolio with 60% stocks and 40% bonds had an average annual return of 6.4%. And the average stock picking investor had an average annual return of 2.9%. Most of us are better off creating a diversified portfolioâ i.e., spreading investments out over multiple different vehicles, so we donât put all our eggs in one basket. A great way to do this is to invest in low-cost index funds, which are a type of mutual fund or Exchange Traded Fundâ AKA ETFâ with a portfolio constructed to match or track the components of a financial market index, such as the Standard and Poorâs 500 index, which you might hear referred to as the S&P 500. Basically there is a real human tendency to think that the more involved we are in something, the better the results will be. But usually with investing, the exact opposite is the case. What is most boring, and simple, and passive usually yields the best results, literally.
5. Spending less is not the same thing as savingÂ
So buying things on sale can be a great way to spend less on an individual item, but itâs also just a marketing scam to get you to spend more overall. It can be very easy to feel like you have to take advantage of certain sales. And to be fair, if there is a specific item that you were planning to buy regardless, waiting to buy it at the best possible price is the best way to do it. But buying things just because you feel like youâll miss out on a great deal is not saving money, especially if itâs money you were not planning to spend. Stores also like to say, âbuy more save moreâ and to buy ropers into bundling more. For instance, if you were just planning to buy one shirt, but then thereâs a deal that says, âbuy two get one free.â You didnât get a free shirt. You just spent twice as much as you were originally planning to spend. The psychology of sales and how theyâre used to market to people is not only a very well-known tactic, itâs also exploded with the advent of social media, where basically everything is always on sale, and everything is always being marketed to you. Knowing the difference between getting a good deal on money that you had already allocated and just being tricked into spending money you didnât want to is a crucial component of making much better consumer decisions. And similarly, budgeting is not the opposite of spending. So many people hear the term budget, and they automatically think in terms of limitations and restrictions, that if youâre on a budget, itâs automatically going to feel like youâre not allowed to spend money. But for me, one of the most liberating aspects of getting control over your money is that itâs actually not at all about restriction. Itâs about permission. A budget is simply a plan for knowing exactly where your money is going and having a very clear picture of how much you can afford to spend on any given thing without having to worry about it. Budgets also donât work if theyâre not realistic. If you try to make a budget that cuts out all possible fun spending, youâll ultimately not stick to it. Youâll get discouraged and maybe even give up trying to budget altogether. But more importantly, as someone who used to be extremely avoidant with budgets and now loves them, itâs so important to remember the incredible mental freedom and relief that youâre giving yourself by never again having to worry about whether or not you can afford something. To always know that you can afford to buy what youâre buying and that it doesnât come at the expense of your other goals, to not have to do that awkward dance at the checkout because youâre not sure how much money is in your account, and to not have to feel guilt over the things that you enjoy spending on because theyâre already planned for is one of the most transformative things you can do in your life.
6. Restricting your spending will not allow you to build up wealth nearly as effectively as bringing in more moneyÂ
So much of personal finance advice is centered around limiting your spending as much as possible so you can allocate more of it to savings and investments. But the reality is that you can only cut down expenses so much. And in the long term, itâs much easier to save more when you earn more. Unfortunately wage stagnation is the reality that most Americans are faced with. Quote, âwages in the US have stagnated since the early 1970s.â and âBetween 1979 and 2020, workersâ wages grew by 17.5%, while productivity grew over three times as fast at 61.8%.â But the sooner you start earning more, even just incrementally, it will exponentially increase the total amount that you could earn and thus save in your lifetime. Just a $5,000 raise earlier in your career could be worth over $600,000 in your lifetime. And chances are, for most people, if youâve been at a single employer for more than a few years, you are being underpaid compared to your market value. That could mean changing employers, which is usually what people need to do to realize the bigger pay increases in their career, or it could mean renegotiating with your boss. Iâm going to link you guys in the description to some of our best videos on the topic of negotiation. But suffice to say, if you are not constantly advocating for yourself, both at the time of hiring and throughout your time at an employer, you are totally shooting yourself in the foot, not just today, but for the rest of your life.
7.Keeping a running credit card balance is not good for your score
So this is something that so many people get wrong because, quite frankly, itâs in the interest of credit card companies to make you think that itâs true. Not only is keeping a running balance on your credit card not necessary and can work against what is called your credit utilization ratio, which is a big factor in calculating credit scores. Itâs basically the amount that you do spend versus the amount that you can spend every month. It also ensures that youâre paying interest every month, which you should never be doing if you can at all avoid it, and puts you in high danger of credit card debt. Now, aside from the fact that keeping a balance on your credit score each month will necessitate you paying interest on that amount, to get back to the credit utilization ratio specifically, credit bureaus want to see that youâre keeping your usage rate under 30% of your available credit, although lower is better. And not only should you not keep a running balance, paying off your credit cards in full and on time is a foolproof way to make sure that youâre maximizing that percentage. If you routinely use more than 30% of your credit card maximum because your limitâs not very high, consider calling your credit card company and asking them to raise your maximum. And then donât spend more on your card than youâre currently doing, which conveniently brings us to the next point.
8. Almost everything is negotiable, including debt
When weâre presented with a number for something, it is often our instinct. And for many of us, a sense of politeness obliges us to take it at face value. But many things are much more negotiable than we thinkâ things like our monthly bills, utilities, our car payments, rent, and, yes, even debt we might be carrying. For the rent, for example, it is not just negotiable when youâre first signing a lease, itâs also negotiable every time your lease is up for renewal. And itâs important to remember how valuable keeping a good tenant is rather than having to find a new one. I basically negotiate on every single thing in my life. And one thing that Iâve always used to my advantageâ and this is also something I experience in the opposite direction as an employerâ is that keeping someone is almost always better than having to replace them. So when an employee negotiates for a higher raise, I always keep in mind how valuable it is to me to keep them happy rather than having to find someone new, which has both literal and opportunity costs. Similarly for your landlord, replacing you as a tenant would be very expensive. For bills that youâre paying every, month things like your phone and internet, itâs very valuable to the company to keep you as a customer rather than having to find a new customer because youâre going to another service. Continuity is leverage, and debt is also something where you have a lot more leverage than you think, especially if a debt has gone to collections, which Iâve had debts due in the past and negotiated down the amount I ultimately settled for. Iâm going to link you in the description to a whole explainer on how to negotiate down with debt collectors. But just bear in mind that when it comes to money you owe, everything is up for negotiation.
9. You shouldnât necessarily aim to get a tax refund
Getting a tax refund is something that many people rely on every year as itâs a quick windfall to put into savings or to cover expenses. But a refund just means that you were overpaying taxes from the previous year in the first place. If you update your W-4 form, you can make sure that the correct amount is withheld, which means that youâre less likely to get a refund. But your regular paycheck should be slightly larger and actually correct. But on the other hand, many people view a tax refund as having given the government an interest-free loan. At the end of the day, if, for mental health reasons and for planning reasons, itâs better for you to aim for that refund rather than making sure that youâre not overpaying throughout the year, Iâm not going to tell you to stop doing it. But it is important to remember that tax refund isnât some magical bonus. Itâs money that was already owed to you in the first place and has just been withheld from you for about a year or so. If you can get to a place where youâre able to manage your finances in a healthy way without depending on that windfall every year, thatâs a better way to go. But ultimately, itâs your decision.
10. Even if you make a lot of money, your spending still matters
 A lot of people operate under the misconception that once you reach a certain level of wealth, your spending no longer really matters. And as I mentioned earlier, earning more is usually the key to saving more. But earning more doesnât mean anything if youâre spending habits are outpacing your income, which is a very common problem with high earners. And itâs usually because these high earners fall victim to what is called lifestyle inflation, where essentially everything in their life starts to become more expensive as their tastes develop, as theyâre able to afford nicer things, and especially as the social groups around them are also engaging in those very luxurious lifestyles. Living below your means and tuning out the noise of what people around you either can themselves afford or expect you to be able to afford is essential to staying financially healthy. And you would be shocked at the number of high-earning individuals who live paycheck to paycheck, especially once, for example, they have children who have private schools, and tutors, and classes, and all kinds of other things that, for many of usâ for example, myselfâ were simply not a part of childhood growing up, but which once you get into higher earnings circles, can become basically a social necessity. If you fall victim to peer pressure when it comes to your spending habits, basically no amount of money will ever be enough, and youâll be trapped in a cycle of spending and lifestyle inflation, no matter how much you earn. Those are just some of the things that people generally get wrong about money and what is actually the right answer. But there are many more, and so weâll do another video like this in the future. And if I missed one, please go ahead and leave it in the comments because I always love to hear what you guys have to say about managing your money in a way that is TFD-approved.
