5 Most Common Money Traps to Avoid
Successfully managing your finances isn't just a matter of doing the right thing. It often also means avoiding doing the wrong thing, particularly when the wrong thing involves doing nothing at all. A sin of omission, if you will.
Fortunately, awareness is the first step in avoiding such missteps. Here are five common ones, along with some fixes you can use in your investing life.
1. Putting off saving for retirement
When you're in your 20s, it can be hard to prioritize your retirement—it seems far-off and making a day-to-day budget work may be challenging when you’re starting a career. Soon enough you reach your 30s, and your priorities may shift to saving for a house or paying for childcare—still not an easy time to save for retirement. The fact is, it may never be easy. But it will always be necessary.
The fix: As soon as you start a new job, sign up for your employer's 401(k) plan, if you’re not automatically enrolled. If your employer doesn't offer one, set up an individual retirement account (IRA) and automate your monthly deposits. If you don't get used to having extra money in your paycheck, you won't miss it when it automatically goes into your retirement savings. Plus, if you start early, your earnings will have a chance to generate more earnings, potentially growing your savings at an accelerated rate over time—that’s the power of compounding.
2. Skimping on an emergency fund
Are you financially prepared for a surprise home repair, medical bill, or temporary job loss? Getting hit by an unforeseen (and pricey) expense can knock your finances for a loop.
The fix: Stash away three to six months’ worth of cash in a separate account to cover essential living expenses. The number may be daunting, but you don’t have to get there overnight. Funnel part of your paycheck automatically to a separate account and you’ll make steady progress over time. And remember to increase your savings rate as your earnings—and cost of living—go up.
3. Overreacting to sudden market moves.
How do you react when the market takes a sudden dive? Do you panic and start selling? Or do you ride it out? Investors with the fortitude to take the long view tend to do better. For example, someone who cashed out during the worst of the COVID pandemic would have missed one of the fastest recoveries in history.
The fix: Stay invested. Day-to-day market fluctuations have little impact on your long-term goals. The Schwab Center for Financial Research has found that staying invested over the long haul—and not trying to time swings—can be the best way to participate in the market. If you have a history of fiddling with your portfolio right after a major event, consider looking at your account less frequently—say semi-annually or annually.
4. Staying in cash.
Market volatility may be scary, but it doesn't last forever (with due recognition that past results can’t be guaranteed in the future). So, keep your time horizon in mind when you're investing in stocks. Even though stocks can be volatile, it may be reasonable for a young person to put most of their retirement savings to work in the stock market. Even retired investors should consider having at least some stocks.
The fix: You don’t have to jump in cold. Get in the habit of investing by moving a portion of your cash savings into a diversified portfolio each month. This approach, known as "dollar cost averaging," potentially allows you to buy more shares when prices are low and fewer shares when prices are high. If you have a significant amount of money to invest, dollar cost averaging can reduce the impact of market volatility on large purchases.
5. Dedicating too much to a particular asset.
Loading up on one investment can be pretty easy. Maybe it’s stock in the company we work at or municipal bonds inherited from a relative. But there's a benefit to owning many different types of investments. Having that variety in your portfolio—also known as diversifying—can help make your portfolio more resilient when volatility hits a particular swath of the market. Why? Each investment might respond differently to changes in the market or economy. If geopolitical events shake up your international stocks, for example, U.S. bonds might rise and help smooth out your portfolio’s return overall.
The fix: Make sure that you have investments across numerous sectors, industries, and geographical areas. Once you have a diversified portfolio in place, revisit your portfolio’s allocation mix on a yearly basis to make sure it still aligns with your investment goals.