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by Walecia Konrad, AARP The Magazine, June 04, 2007
If a penny saved is a penny earned, then the following money-saving tips could bring you thousands of dollars—cash you could use to secure your retirement, renovate the kitchen, help your favorite charity, or start a college fund. If that sounds more appealing than throwing money down the drain, take ten minutes and read this list of financial no-no’s that will cost you big.
Loading Up the Plastic
Debt needn’t be a trap, but for a growing portion of Americans it’s at least a bad habit. Comparing debt levels in 2004 with earlier years, the Employee Benefit Research Institute found that families headed by someone 55 or older were carrying more debt than before and had lost ground no matter their income level. More families were in debt as well. In 2001, 56 percent were in debt; three years later the figure had climbed to 61 percent.
Credit cards are the big troublemaker. The average household in the United States has almost $7,300 in credit card debt, according to lending monitor IndexCreditCards.com. Paying the monthly minimum—often 2 percent of the balance—isn’t nearly enough if you want out of the red. Compounding at a typical 14 percent a year, that average balance would take over six years to clear, at a cost of more than $3,700 in finance charges.
To get out from under, consider scaling back your lifestyle, getting a low-interest loan from a credit union, or (if you can retire a debt in months) transferring balances to cards with lower introductory rates. If you switch to a debit card to rein in your spending, be sure to cancel any overdraft protection, which can saddle you with charges for overdrawing your account that are worse than any credit card rate.
Tapping Out Home Equity
Paying off credit card debt with a home equity line of credit—and deducting the interest—has been a popular move in recent years, as home values soared and mortgage rates hovered near historic lows. But now that real-estate prices are stalled or slipping, extracting cash is riskier business for the 23 percent of homeowners with a home equity loan or line of credit.
“People who’ve racked up big balances are starting to see the effects,” says Robert Manning, author of Credit Card Nation (Basic Books, 2001). “When they go to sell, they’re finding they owe more on the house than the sale price, and that’s not pretty.”
If you counted on rising home prices to keep you solvent, now’s the time to find Plan B, while interest rates are still relatively low. If you have an adjustable-rate loan, consider refinancing to a fixed-rate mortgage, or look into moving to a cheaper place.
Not Getting Your Due
There may be money out there with your name on it. An estimated $24 billion in savings accounts, stock dividends, paychecks, utility deposits, and insurance proceeds are waiting to be claimed. By law, companies must turn this money over to state governments for safekeeping. To find yours, go to www.unclaimed.org, run by the National Association of Unclaimed Property Administrators, and start by clicking on the link to your state’s site. Then be sure to check every state in which you’ve ever lived. It’s a free service. To make sure you get all the Social Security money you are due, check the yearly statement that arrives three months before your birthday each year. If you see errors in your earnings record (or never get a statement), call the Social Security Administration at 800-772-1213. If you’ve changed your name, you need a new Social Security card—but not a new number.
Ignoring Your Debt Limit
Lenders’ limits on borrowing have gotten lax, and that’s dangerous—for you. Banks used to refuse home loans when the payment, taxes, and insurance exceeded 22 percent of gross income, or total debt payments topped 28 percent. Lenders may turn a blind eye, but you shouldn’t.
Failing to Plan
Fidelity Investments surveyed people ages 43 to 70 and found that with more than 30 percent of couples, the husband and wife gave completely different answers when asked when, where, and how they’ll retire.
David Bach, an investment adviser and author of Smart Couples Finish Rich (Broadway, 2002), has seen this firsthand with a couple on the brink of retirement. John had bought a few acres of land in South Carolina 20 years before and was ready to build his dream house. But Lucy, his wife, had other ideas. “And who are you planning to move to South Carolina with?” she asked her husband in front of Bach. The couple had never talked together about their wishes. Suddenly that land didn’t look like such a good investment.
People with financial goals have more than double the wealth of those without, according to a study by scholars at the University of Pennsylvania and Dartmouth College. It’s never too late to start planning. Pick a quiet time and place for such discussions, says Jean Chatzky, author of Make Money, Not Excuses (Crown Business, 2006). The time to plan is not just after a huge fight about who’s spending too much. If the two of you can’t make headway, sit down with a financial planner or other trusted third party who can help you come to an agreement about the future.
Forgetting to Rebalance
Just about everyone who invests is familiar with the idea of diversification: you spread your money among several kinds of investments—stocks, bonds, cash accounts, real estate—so when one area loses its footing, your entire portfolio doesn’t stumble.
Say you invest 60 percent of your portfolio in stocks, 30 percent in bonds, and 10 percent in money market funds. The stocks are further diversified, with shares of companies large and small, domestic and foreign, volatile (growth stocks) and steady (value stocks). Of course, because investments grow at different rates, with time those allocations will get out of whack. Suddenly a high-performing stock fund is 25 percent of your portfolio, for instance. Bringing your holdings back in line every six months is called rebalancing, and plenty of us put it off because it’s counterintuitive. It means selling your winners and reinvesting in what seem like losers. But here’s a better way to think of it: rebalancing lets you buy low and sell high. For real convenience, here’s a tip: buy a diversified index fund geared to your expected retirement date. These funds—known as target-date or life cycle funds—are already well diversified. The funds’ managers keep things in balance for you.
Buying Variable Annuities
The cardinal rule of investing is, keep things simple, and variable annuities are anything but, melding the potential for growth that comes from stock investing with the guarantee of a steady income that all annuities are supposed to provide. Mixing motives costs you. The average annual expense fee for a variable annuity is 2.39 percent of assets, compared with the average mutual fund expense fee of 1.36 percent. (To see what a difference 1 percent can make, check out the chart below under "Paying High Fees to Invest.")
Need we say more? We could, because that number doesn’t even include sales commissions or surrender charges applied if you pull your money out years later. And the fund monitor Morningstar reports that the average variable annuity underperformed the average mutual fund no matter what time span it examined—one year, three years, five years, or ten years. For the past ten years the average variable annuity invested in stocks posted an annual return of 6.72 percent, compared with the average fund return of 8.71 percent.
Scoffing at Library Fines
Local governments are like the rest of us—they’re looking for more money. Some are finding it by hiring collection agencies to deal with unpaid parking tickets and even library fines. “More and more people are complaining about this,” says Craig Watts of credit scorer Fair Isaac. “It started about ten years ago [with] strapped municipalities, especially big cities.”
The consequences are not small. A debt going to a collection agency can drop your credit score by 100 points overnight, Watts notes. That means beach reading you’ve hung on to since last summer can raise the interest rate you’ll pay on your next car loan. Time to sort through that stack by the bed.
Paying High Fees to Invest
It’s indisputable: the more you pay in commissions and fees for an investment, the less profit there is for you. So never pay sales commissions—called loads—on mutual funds, and give preference to lower-fee index funds. You can compare the expenses of any fund against rivals in its category at www.morningstar.com.
Missing Out on the Match
Here’s a $30 billion mistake: that’s how much matching funds Americans miss out on each year because they aren’t saving for retirement through their company’s 401(k) plan.
If your employer matches any part of contributions to a 401(k) —and four out of five plans do—sign up and take full advantage. It’s free money on top of a tax break, since what you set aside isn’t subject to income tax.
The boost the match gives your retirement can be astounding. Say your company offers the most common match of 50 cents on the dollar on anything up to 6 percent of your salary. If you make $68,000 a year and earmark 6 percent for your 401(k), you’ll get $2,040 in matching funds. Over a 20-year span at an 8 percent average return, you’ll have about $300,000—and more than $100,000 of it because of the match. Who can afford to leave that kind of money on the table?
Walecia Konrad is a freelance writer specializing in personal finance. She writes the MoneySmart column for USA Weekend.
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