April is National Financial Literacy Month. Why do we dedicate this calendar page to highlighting financial skills and education? The tax deadline? Sound financial decisions are important all year long, but most Americans never learned how to manage money or save for goals, so financial security is a bigger challenge than it needs to be.
Even if you can handle the math involved — and calculators can help if you can't — things get complicated when making large (often-emotional) financial decisions. Some of the most common pitfalls are described below. If you recognize any of them, you're not alone. The good news is that you have an opportunity to improve your finances and save more money.
An emergency fund is essential because you need to absorb life's surprises without making things worse. Without a stash of cash, you'll have to take on debt — often at high interest rates — for unexpected car troubles or surprise medical expenses.
A 2016 Federal Reserve study found that 46 percent of U.S. consumers would "struggle to meet emergency expenses of $400." Roslyn Lash, an Accredited Financial Counselor ®, has worked with clients in that situation, but there is hope. "Oftentimes, it's not a lack of resources, it's simply a lack of knowledge and discipline," says Lash. She suggests paying yourself first to build up an emergency fund: make sure that your savings and other financial goals are taken care of before you allow yourself to spend money on less-important items like that Frappuccino.
Retirement Savings Shortfall
Americans are dangerously underprepared for retirement. Your expenses don't take a break when your income stops, so you'll need a source of funds to pay for food, housing, healthcare, and all the fun you planned for your golden years.
Are we saving enough? The median nest egg for U.S. households amounts to just $5,000 according to the Economic Policy Institute. That includes all households — including those that have never saved a penny for retirement. If you just count households that are actively saving, the picture isn't much better: the median amount saved is $60,000 (a nice sum, but it won't last long in retirement).
"Some people are fortunate to receive pensions and others are fortunate to live simple lifestyles that can be sustained by Social Security income," says Jennifer E. Myers, CFP®, and President of SageVest Wealth Management in McLean, VA. However, the maximum monthly payment from Social Security in 2017 (assuming full retirement benefits at age 66) is $2,687. Most people will get less than that, and it probably won't be enough.
To avoid a nasty surprise in retirement, run some numbers. Figure out how much you'll get from Social Security, decide if you'll need more, and calculate how much you need to save each month to fund that goal. "Almost every American requires savings to supplement their retirement," says Myers. To calculate your needs, try our free Retirement Planner.
Unless you understand the true costs of loans, it's easy to borrow too much and pay interest at high rates. According to the Federal Reserve, that's exactly what we're doing, and household debt levels have risen to roughly the same levels seen just before the Great Recession.
The Fed reports that the average U.S. household had $16,748 in credit card debt at the end of 2016. Add student loans of $49,905 and an auto loan of $28,948, and you're talking real money. When the median household income is just over $55,000 per year, those debts seem nearly impossible to pay off, and it's no wonder that student loan delinquencies are reaching all-time highs.
During her years as Chief Marketing Officer at Conestoga Bank in Philadelphia, Holly Wolf worked to provide education to consumers, but she repeatedly saw the same mistakes:
- Buying based on monthly payments: Auto dealers are notorious for focusing on how much you can spend each month, and somehow making the payments work. However, you're missing the opportunity to negotiate a lower purchase price on the vehicle. Also, Wolf explains, lenders can lower your payment by stretching the payments out over more years.
- Ignoring interest costs: A loan with a longer term will cost more. The payments on a 30-year mortgage are smaller than 15-year payments, but you're paying interest for an extra 15 years, and the extra cost is significant. The same is true, to a lesser degree, when choosing between 48-month and 84-month auto loans.
- Borrowing the maximum: Mortgage lenders always tell you how much you can borrow, but that's your maximum limit. You don't need to take the entire amount, and it's probably not wise to do so. Plug the monthly payment into your budget and see if you can truly afford it. Next, look at how much you'll save on interest costs if you choose a less expensive property or make a larger down payment. MoneyTips is happy to help you get free mortgage quotes from top lenders.
- Credit cards: Borrowing on plastic is expensive, especially after "teaser" periods end and your interest rate converts to a double-digit monster. But those minimum monthly payments are easy to keep up with — until they're not. When interest charges add up to several hundred dollars each month, you'll have to work hard to make a dent in your balance. "If you can't pay off the credit card each month, don't use it," says Wolf.
Expensive Banking Services
A bank account is a necessary tool for everyday spending and keeping your cash safe. For some, it's an expensive tool. Americans paid $11.2 billion to banks in overdraft fees alone in 2015. That doesn't even include monthly maintenance fees or interest on loans.
To minimize costs, find a free checking account at a bank or credit union, or find out how to qualify for fee waivers in your existing account. For example, some banks eliminate monthly charges after you set up direct deposit. Holly Wolf says that "fees are preventable," and suggests setting up overdraft protection from a savings account (instead of paying higher fees to borrow from the bank).
Some people live day-to-day without banks. They might distrust banks or hate the fees, or they might be unable to open an account at a traditional bank. But alternative financial products can lead to trouble, says Michael Dickey, a Certified Financial Education Instructor who leads financial wellness events. Dickey cited a recent study showing that 42 percent of Millennials have used alternative products like payday loans, rent-to-own stores, and pawnshops.
Check-cashing stores are arguably useful — particularly for people who can't get a bank account. Payday and title loans are easy to use, but you'll pay in the form of steep fees and interest charges. "It's extremely hard to get out of that cycle of debt," says Dickey, who proposes budgeting and saving monthly to avoid using expensive loans.
Challenging Investing Behavior
There are no guarantees when it comes to investing, but it seems that pessimism has put investors on the sidelines while markets have moved to all-time highs. A recent study found that 23 percent of people think cash is the best place to invest money that won't be used for at least ten years, and 25 percent prefer real estate. At the same time, savings accounts (cash) are paying slightly more than nothing.
Long-term investing is fairly simple: Determine how much risk you can afford to take, spread your money among different investments, keep your costs low, and avoid rash decisions. You don't have to be ultra-conservative or super-aggressive (although you can choose either if it makes sense) — there's an entire spectrum of risk to choose from. Cash might be the right investment for the next ten years, but history suggests that other options might do better against inflation.
Investing in the markets is best done with a long-term perspective. But behavioral biases prevent us from making use of tried-and-true investment principles, according to Genti Cici, CFP®. Most investors are driven by fear and greed, and they're impatient. "Without having a plan or diversifying, both key components of financial literacy, clients bounce from one stock [or] fund to another not understanding why there's not much performance."
The Ultimate Cost
You can't buy happiness, but financial troubles can easily cause misery. According to the American Psychological Association, "Money, work and the economy continue to be the most frequently cited causes of stress for Americans, as they have every year for the past 5 years."
While employment opportunities and other factors affect your finances, a bit of education or a change in your perspective can really pay off. Try following MoneyTips' 10 Commandments of Personal Finance. Financial advisor and author Jonathan DeYoe, CPWA, AIF, suggests using mindfulness to understand what you really want and why you want it. Don't just go with "what the culture wants," which is an expensive house, car, and dinner on the town. With a solid understanding of affordability and how loans work, DeYoe explains, an individual could have avoided the worst of the recent financial crisis. On a broader scale, the financial system itself might have been less fragile with better financial literacy.
If you're not quite ready to save the world, the benefits of financial literacy can go to you and your loved ones. Matt Becker, CFP®, founder of Mom and Dad Money, explains that money problems create "a lot of day-to-day stress that could be relieved with a better financial education and support system in place." Keep striving to achieve financial literacy even when April ends: Commit to checking your credit for free regularly during National Recommitment Month (May); Balance your budget while listening to R&B in African-American Music Appreciation Month (June); then treat yourself to a well-deserved sundae during National Ice Cream Month (July)!