Let's face it: Planning your financial future probably isn't the most exciting thing you'll do in your life, which is why it's easy to put it on the back burner without thinking too much about how the way you handle your money will affect your future.
The good news is that you're not alone. In fact, only 38% of Americans have a written, long-term financial plan, according to a Gallup poll, and of those people, only half follow that plan closely.
The bad news is that you could be unintentionally setting yourself up for financial failure, because even small things you don't think much about now could be devastating when it comes time to retire.
1. Not starting an emergency fund
Everybody knows they need to build an emergency fund, or a cash savings to cover three to six months' worth of expenses in the event of an emergency. Yet according to a report from the Federal Reserve Bank, 40% of adults said they didn't have enough savings to cover an unexpected $400 expense.
The problem is that even minor unexpected expenses can cause major problems down the road. If a $100 car repair pops up and you can't afford it, you'll likely have no choice but to pay for it with a credit card. But then when it's time to pay the credit card bill, you probably still won't be able to pay off that expense, so now you owe sky-high interest, too. And the longer it takes you to pay, the more the interest payments continue to snowball.
Not having an emergency fund can also derail your retirement, because when you're struggling to pay for unexpected expenses and then spend months or years paying off interest on those expenses, you're probably not contributing to your retirement fund.
Of course, the tough part is actually saving enough to establish an emergency fund. The first step is establishing a written budget, if you haven't already, to see where you can make cuts in your spending habits. These don't need to be major -- even just saving $10 per week by cooking at home rather than hitting the drive-through is helpful.
Next, try to pick up some extra income where you can. You don't need to find another full-time job, but even a side hustle earning a couple hundred dollars per month can go a long way in stashing away some extra cash. Maybe you're passionate about photography or painting and can sell a few pieces of your work, or perhaps you're an animal lover and can walk dogs in your neighborhood in your spare time. The best thing you can do is just get started, because the longer you wait, the more you're putting yourself at risk for a financial disaster.
2. Borrowing from your 401(k)
When you're strapped for cash, it's tempting to look at the money in your 401(k) as a bank account you can withdraw from whenever you like. After all, it is your money, so why can't you use it the way you want?
Borrowing from your 401(k) can have serious repercussions, though -- especially if you're not careful. You still have to pay back the amount you borrow plus interest (even though that money goes back into your account), and if you fail to repay your loan, you can still default just as if it's a typical loan from the bank.
Also, because your 401(k) is tied to your employer, if you leave your job while you have an outstanding loan, the loan is treated as a distribution and you're required to pay back the full amount in a relatively short period of time. In the past, you had 60 days after leaving your job to repay the loan. But under the new tax laws, you have a little more leeway -- you now have until the due date of your federal income tax return to pay back the loan in full if you leave your job.
Even if you do repay your loan in full and on time, there are still consequences when it comes to retirement. Small withdrawals of just a couple thousand dollars can put a significant dent in your nest egg over time, because you could potentially be losing months of valuable time that your savings could have used to grow.
For example, let's look at two separate scenarios. In scenario one, let's say you're 40 years old and have $50,000 in your 401(k). You borrow $5,000 with an annual interest rate of 4%, and you repay the loan in five years -- repaying a total of $5,525, including interest. After that, you simply let your investments grow without making any additional contributions, earning a 7% annual rate of return on your savings.
In another scenario, let's say that you had not borrowed from your 401(k) and instead simply let your savings grow uninterrupted. Even if you didn't make any additional contributions, assuming you were earning a 7% annual rate of return on your investments, here's what your total savings would look like over time in both situations:
|Age||Total savings after borrowing||Total savings without borrowing|
So even though $5,000 may not seem like a lot of money, those five years you spent repaying your loan rather than letting your investments grow can compound over time and result in potentially tens of thousands of dollars lost.
3. Not taking advantage of employer-matching 401(k) contributions
Saving for retirement is hard, but if your employer offers matching 401(k) contributions and you're not contributing enough to earn the full match, you're leaving money on the table. And while you may not have much extra cash to spare, when your contributions are doubled, even small increases can amount to major gains later down the road.
For example, say you're earning $40,000 per year and your employer will match 100% of your contributions up to 3% of your salary, or $1,200 per year. Let's also say that right now you have $45,000 in your 401(k), you're contributing $1,000 per year, and your employer matches that full amount, bringing your total contributions to $2,000 per year. If you boosted your contributions to $1,200 per year (which is just an extra $17 per month), investing a total of $2,400 per year, here's how much your savings could grow over time, assuming a 7% annual rate of return:
|Years||Investing $2,000 per year||Investing $2,400 per year|
In other words, that extra $17 per month could result in an additional $27,000 over a couple decades.
When you're decades away from retirement, you may not think that the financial choices you make now will have much of an impact. But it's never too early to start planning, and by avoiding these mistakes, you could save yourself thousands of dollars.
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