So you've been working hard and you think you've got this personal finance thing figured out. You're contributing plenty to your 401(k) -- more than enough to collect the free money -- and you've been funding an IRA in recent years, too. You've got 529s for the kids, your credit is in good shape, your mortgage payments are manageable (and not about to balloon), you're spending less than you earn. In other words, you're feeling pretty good. Your finances are in great shape and money troubles don't keep you awake at night.
Don't worry. There are still plenty of ways you can screw it up.
Making arsenic from lemonade
You don't need a freak natural disaster or a horrible accident to cost yourself a million dollars or more by the time you retire. Things like that are like reverse lottery wins -- they almost never happen, but when they do, they're huge and life-altering and probably unavoidable. We all (most of us, anyway) do what we can to avoid them, but sometimes lightning strikes.
That's not what I'm getting at. I'm thinking of situations where it seems like everything is OK, but whether through ignorance or neglect or overconfidence or just sheer pigheadedness, a huge, expensive mistake gets made -- the kind of mistake that can have a seven-figure impact on your future. Mistakes like these:
- Underinsurance. Even in the current soft real estate market, my house is worth about twice what I paid for it nine years ago. If you've owned your house for awhile, that's probably true for you, too. Are you sure your insurance policy will cover the full current value if something happens? How about life insurance? If you bought your policy 10 years ago, based on what you earned then, will it still provide adequate coverage for your family based on your current earnings and lifestyle? Or will they have to tap the retirement funds early just to get by?
- Being too conservative with investments. You don't have to be invested in a basket of volatile growth stocks like Atheros Communications (Nasdaq: ATHR ) or Natus Medical (Nasdaq: BABY ) , but you should have your retirement funds -- anything you won't need within five years -- invested in stocks of some kind. I know that a lot of liability-aware "experts" advise people to start moving into fixed-income investments well before retirement age, and I also know that that strategy doesn't make sense for most people, not even after you're retired. If you've got a million dollars in your retirement fund, and you shift it out of stocks returning 10% and into fixed-income investments returning 5% 10 years earlier than you need to, you'll miss out on around $965,000 in potential returns. That's almost a million bucks! Could you use an extra million in retirement? Are you still sure those bonds are going to help you sleep better at night?
- Death by big fees. If you buy your mutual funds from a broker, you're probably paying for the privilege -- 5% or more up front, for starters, plus an extra 0.25% a year or more in most cases. Compare your fee-adjusted returns over time with what you'd be getting from a low-fee S&P 500 index fund. Having just seen the impact a 5% cut in return can have on your earnings over time, is the advice you're getting from your broker worth what you're paying for it?
- Waging a divorce war. Divorce is never fun, and even under the best circumstances it's full of potential financial pitfalls. But if you turn it into a war, it can be a total financial disaster for both of you. I know of divorcing couples -- ordinary mid-career professionals, not zillionaires -- who fought pitched, protracted court battles over mostly petty nonsense, and ended up burning through more than $200,000 in legal fees. (Where are you going to get 200 grand to pay the lawyers? Out of your 401(k), maybe? What will that cost you over the next 20 or 30 years?) Another divorcing couple I know went through a mediation process. After they came to an agreement in mediation, each hired a lawyer to help draw up the paperwork and sanity-check the final deal. They got through everything for around $5,000, kept their retirement accounts intact -- and added far less gratuitous misery to what was already a difficult period in their lives.
These aren't the only ways to make a seven-figure mess of things -- try adding up the costs of smoking cigarettes, for instance. (There's a reason Altria (NYSE: MO ) is such a cash generator.) But the ones listed above are not uncommon. And worse, they're not uncommon among people who seem to otherwise have their financial acts together.
But those mistakes are avoidable. Just keep aware that they're out there, and you should be able to stay out of those million-dollar holes.