My Biggest Financial Mistakes
We all make mistakes. It’s just human nature to make a mess of things from time to time.
The good news is we always have an opportunity to reflect on our errors so we can do things differently next time, given the opportunity.
One of the most helpful things I’ve learned is that it is easier to take lessons from the mistakes of others than form myself.
It’s like getting an education from the school of hard knocks, only at someone else’s expense.
In that spirit, I’ve decided to tuck my own pride away for a bit and share four of the biggest financial mistakes I’ve ever made.
I do hope you find them useful.
1) Took Baby Steps For Too Long
Yes, this is a reference to Dave Ramsey. I realize that he can be something of a polarizing figure.
For me, there are aspects of his 7 financial “baby steps” that I find both incredibly helpful and others that I cannot for the life of me understand.
Overall, my personal view is that he has done more good than harm for people who follow his basic plan for financial peace.
Truthfully, if all a person ever did was pay off their debt, sock away a real emergency fund, invest 15% of their income (even if they can’t find Dave’s elusive mutual funds that return 12% per anum), then retire and/or give it all away, they’d be doing much better than the vast majority of Americans.
But that doesn’t mean the path would be optimal.
I know this because my wife and I were huge fans of Dave in the formative years of our financial lives, but we gradually drifted from his plan as we realized it didn’t really align as closely as we’d like with our own point of view.
Pay off consumer debt? Check.
Save and invest 15% or more of your income? Check.
Forego employer match to pay off debt? Uh, say what?
This was the first place we began to divert from the baby steps. Our most “expensive” debt that I can recall was a student loan I had after college with an interest rate of around 6%.
The rate of return for an employer matching contribution is 100%.
100% is better than 6%. You do not need a degree in quantitative methods of finance to understand this.
Another rub was the four types of mutual funds he recommends. According to Dave Ramsey, everyone should own growth and income, growth, aggressive growth, and international stock mutual funds.
I’m not saying any one of these is bad, but saying these fund types are good for everyone is an awfully broad brush to paint with.
Furthermore, it completely ignores sequence of return risk. (That is, the risk of needing to sell your investments at the same time they face a steep decline in value.)
Ironically enough, we were following Dave’s investing advice back in 2007, when the Great Recession was just beginning to show itself in the form of a steady decline in the value of stocks, and in 2008 when things got really interesting.
Now, I was in my late 20s then. Being 100% invested in stocks with decades to recover wasn’t a huge deal.
However, if I had invested heavily in stocks at that time and just happened to also be in my 60s I might have croaked.
The baby step four-fund portfolio is not diverse enough for everyone. Sorry, Dave.
Finally, I don’t fully agree that everyone should pay off their mortgage early. There are certainly times it makes sense and there are times it doesn’t, but we’ll cover that more in a second.
Ultimately, I think Dave Ramsey is a helpful voice for those searching for some semblance of a financially viable plan for their future.
It is true that much of personal finance is a mental or behavioral challenge and no one does a better job addressing that than Dave Ramsey.
But, if you want a plan that’s better than good enough, you’ll need to set your ambitions higher than baby steps.
2) Paying Off Mortgage Early
As I just mentioned, my wife and I were big fans of the Dave Ramsey way of managing personal finance.
Before we had kids for whom we could save for college we had reached baby step 4 (invest 15% for retirement) and were ready to move to the next level.
Since we were following the baby steps, this meant we were ready to begin paying off our mortgage early.
Now, before I explain why this was a mistake for us, let me explain some situations in which paying off a mortgage early makes perfect sense.
High Interest Rate
If you’re considering whether or not to pay off a mortgage early, you’re probably choosing between that and investing the money elsewhere. That usually means the decision to direct money toward paying down a mortgage is also a decision NOT to invest that money.
So, the interest rate of your mortgage (what the debt costs you) is competing against the interest rate of a potential investment (what that money could earn for you). If you have a mortgage with an interest rate that is higher than what you could expect to receive from an investment with a similar risk profile (pretty low, btw), then it might make sense to pay off your mortgage.
I prefer to use 10-, 20-, and 30-year treasuries as a baseline for comparing one’s mortgage interest rate. If your mortgage interest rate is more than 1% or 2% above that, I’d consider it a high interest rate.
You Are Approaching Retirement
I am a big fan of paying off the mortgage before retirement. Once you stop working and drawing regular income from an employer, you’ll have a much higher degree of control over the income you expose to taxes each year because you’ll probably be pulling much of it from your own retirement or other investment accounts.
This is an enormous tax advantage because it could allow you to keep your income taxes very low.
Unfortunately, if you are still carrying a mortgage in retirement, you may have to realize income from your retirement accounts to make the monthly payments. That means you’ll be paying taxes in order to pay off your mortgage.
A higher income also means your Medicare premiums could be higher than they would otherwise be.
You could potentially store up enough cash prior to retirement to pay off the mortgage without realizing any new income, but I’m not sure that would be an efficient use of your cash. I also have my doubts about whether or not it would be worth the trouble, but I suppose that’s more of a subjective issue.
There may be other reasons to pay off the mortgage early, like maybe just because you want to, but let’s get back to why it was a mistake for me. There were a couple of reasons.
First, we had a relatively low interest rate at the time. For much of the period between 2008 and 2022, interest rates were very, very low. Ours was 3.5%.
The S&P 500 returned just under 20% on average annually during that period.
I gave up 20%, so I could pay off 3.5%. I don’t know how to type out a forehead slap, but if you can imagine it that’s what I’m doing between the lines here.
The other reason paying off the mortgage turned out to be a not-so-great idea was more psychological, but I think it’s worth mentioning.
In November of 2015, I was laid off from the job I had taken just twenty months earlier.
We did have a fully funded emergency fund to ride out several months of unemployment, but I was kicking myself for directing cash into our illiquid house for months before the layoff.
Did I need it? Not really.
Did I wish I had access to it instead of a lower mortgage balance? You betcha.
October 2015 was the last time I made a payment to the mortgage company holding the note on my house a day earlier than I had to.
That period in my life taught me the value of liquidity which is something your house just can’t offer you very conveniently.
3) Buying Too Much House
While we’re on housing, another mistake is that I once bought too much of it.
My wife and I purchased a house as we were getting married. I know many of you may wonder how that would be possible for someone who wasn’t even 25 years old but remember that I live in a very low cost of living area and we were a two-income household with no kids.
It was also about 20 years ago.
We knew we were fortunate to even have the opportunity to buy a house so early in life. I guess we also assumed that if some was good, more was better.
So, for some reason, even though we didn’t plan to have children for several years, we bought a three-bedroom, 2,600-square-foot house for my wife, and me, and that’s it.
It was spacious.
My son would arrive six and one-half years later. Until then we used one of the extra bedrooms for guests that occupied it a total of 2-3 nights per year and the other as our home office (even though remote work wasn’t an option for either of us).
That was six and one-half years paying taxes for, insuring, cleaning, maintaining, heating, and cooling hundreds of square feet that we barely used.
I haven’t calculated the total cost of that over the 10 years we lived there, but I think I might get a little nauseous if I did.
Did you hear that? It was another forehead slap.
Ironically enough, we now live in a house with two kids and a dog. Total square footage: 2300. That’s 300 fewer square feet than our first house and it is perfectly adequate, though I suspect we’ll move again one day to give the kids a little extra space.
Do yourself a favor and buy what you need, not what you think you might occasionally want.
4) Rothed When I Should Have Traditionaled, and Traditionaled When I Should Have Rothed
Technically, I didn’t do so bad on this one, but it still bugs me a bit.
Early on in my working career, my wife and I saved about 15% of our annual income.
We’ve always contributed enough to our employer-sponsored 401(k)s to get their matching contributions, then fully funded a Roth IRA every year.
Once the Roth is full, we’d come back to the 401(k)s until we hit 15%.
For several years, our income was such that we were in the 15% tax bracket (this bracket was pushed down to 12% in 2018). Because we were in one of the lowest tax brackets, the Roth IRA contributions were a no-brainer.
For a time, we also had the ability to make Roth 401(k) contributions, but because I was stupid, I passed that opportunity up to be more “tax-diversified”.
How dumb is that? </forehead swat>
Look, there is a time and place for tax diversification, but it never makes sense to pay more tax for the sake of having a diverse set of accounts from a tax perspective. I literally did exactly that.
Eventually, my affection for Roth accounts grew leaps and bounds and I adopted the mindset that I should just put everything in a Roth.
Most of the time, that’s the right way to go, but as your income increases and your marginal tax rate follows, there may come a time when you should move to traditional contributions.
I haven’t made this mistake yet, but we now make enough that we’re in more of a questionable space about whether Roth or Traditional is the better way to go.
Generally, if your combined state and federal marginal income tax rate is below 25%, Roth is the better way to go. If your combined state and federal marginal income tax is above 30%, Traditional contributions will be more efficient.
If you’re between 25% and 30% you can follow your heart. Or you could just do a little of both like we do.
Conclusion
So, there you go. No one is perfect; certainly not me.
Hopefully, you can learn from some of my mistakes and dodge the head-slapping regret I feel as I read back over these decisions.
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