According to a 2021 study by Charles Schwab, 15% of all investors started in 2020. Here are a few common mistakes both new and seasoned investors make that can cost you thousands of dollars but are easy to avoid.
Basing Investing Decisions On Interest Rates Instead Of Actual Dollars
A common trap people make is choosing to invest when they have debt because of what they think is simple math. They’re often told by financial advisors that their interest rate is low, but the return on investments like stocks is higher.
So, it seems like simple math to compare interest rates and invest versus paying off debt. But when you actually plug in dollar amounts, you might be losing more money than you think.
Some of my millennial peers have carried their student loans into middle age and might even do so into retirement. Borrowers ages 35 to 49 make up the highest number of people owing more than $100,000. In 2016, two months after completing graduate school, I resolved that I would pay off my $72,000 of student loans in two years instead of 10.
Using a student loan interest calculator I learned my loans with an average interest rate of 4% were accruing $7.92 daily. I was shocked because I thought the interest accrued monthly like my savings account.
I also realized that as a beginner investor with only a few hundred dollars to spare each month, it was highly unlikely I would find an investment option that would earn me the same in interest or appreciation to make back my student loan interest.
Underestimating The Power Of Paying Off Debt Before Increasing Investments
Interestingly enough, the fear of missing out still motivated me to pay off the debt even faster so that I could get back to investing as soon as possible. The process came with many trade-offs, including downsizing from two cars to one, forgoing some vacations, living off of one income instead of two, and carefully budgeting our daily expenses.
There were definitely sacrifices in our discretionary expenses that many of our friends thought we were overly frugal about. But my husband and I surprised ourselves by paying off the $72,000 in one year instead of two, encouraging me to exhaust all other options before ever taking on debt again.
Once I built the courage to leave my day job, I opened up my own 401(k) to also max out, match myself and contribute more to profit sharing. We now have contributed at least $50,000 on an annual basis since becoming debt-free — a huge increase from the $6,000 per year we would have contributed had we stayed in debt.
We also feel so much more relief knowing we have fewer debt accounts to manage, especially since many of my peers are concerned about student loan repayments returning.
Withdrawing From Retirement Accounts Too Early
A record number of Americans used their 401(k) plans in 2022 for hardship withdrawals. This type of early withdrawal can help if you face emergencies like medical care or eviction. However, since the Covid-19 pandemic, I have seen people withdrawing for non-emergency expenses to start businesses, buy cars or purchase discretionary items.
Unfortunately, in our twenties, my husband and I thought of our 401(k) as a black hole for our money. I regret how we took tens of thousands of dollars out of retirement savings to buy an investment property because back then we weren’t financially or emotionally mature enough to make good investment choices.
Evenwith a tax bill and a 10% early withdrawal penalty, we cared more about short-term gratification than long-term patience, and decided to withdraw the money anyway. We simply followed general trends and generic advice, even when those didn’t necessarily make sense for us.
Use Your Retirement Accounts To Honor Your Future Self
Since then, we’ve committed to learning and understanding the tenets of financial independence and calculating how much we need to retire at all, let alone early. We learned a modest lifestyle of $4,000 per month would require a FIRE (financial independence, retire early) number of at least $1.2 million in investments.
Now that I know and understand how retirement plans work, I don’t recommend doing that again for a discretionary purchase that you could save up for instead.
We’ve each contributed the maximum allowed by the IRS. And if we have cash flow issues, rather than withdraw, we plan to pause our contributions instead.
Now we look at the purpose of tax-advantaged accounts as saving up for our future selves, and helping us save on taxes that we otherwise would have to realize in regular brokerage accounts.
By reframing your retirement accounts as your future freedom fund, rather than the boring accounts most of us ignore, you can become a great investor without overcomplicating your strategy.
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