The Disasters That Can Ruin Your Finances (and How to Avoid Them)
To protect against floods, some people build houses on stilts or pilings. For tornadoes, there are storm cellars. And in the event of a fire, most buildings have (mandatory) smoke detectors and fire extinguishers. There’s no doubt the idea of a disaster can be terrifying, but in many cases they can be avoided—or at least insured against—with some smart planning.
The same holds true for financial disasters. We talked to financial planners across the country about the disasters they’ve seen derail clients’ plans—and exactly how you can dodge them.
Putting Off Buying Life Insurance
“If you love your children, get life insurance,” says Chris Chen, wealth strategist at Insights Financial Strategists in Waltham, Massachusetts. Blunt, yes, but also right on target. Life insurance isn’t optional when you have other people depending on your income, he explains. Kelly Graves, certified financial planner at Charlotte-based Carroll Financial Planners, agrees—and he’s seen this disaster firsthand involving a family with four young kids. “You can’t necessarily avoid the death,” he says, “[but] you can avoid the financial catastrophe.” As for how much life insurance to buy? Ten times your salary is a good starting point, but it’s important to remember you’re not just replacing income, but also benefits, health insurance, retirement contributions, college tuition and more. Before making the purchase, it may be a good idea to speak with a fee-only financial planner (i.e. not an advisor who is going to try to sell you life insurance) to make sure you’re buying the right amount for you and your family. You can find one who charges by the hour through Garrett Planning Network.
Buying a New House Before Selling the Old One
Just as it’s rarely a good idea to leave one job before you’ve signed the paperwork on the next one, you should avoid buying a new house until you’ve officially sold the old one—or at the very least until contracts have been signed. Otherwise, you run a greater risk that the sale drags on (or falls through) leaving you to handle the responsibility of two residences—as well as two sets of property taxes, upkeep and all the other costs associated with homeownership. “It can take [people] down,” says Susan Kaplan, president of Kaplan Financial Services Inc. in Newton, Massachusetts, who currently has two clients in this situation. “There’s nothing as painful as supporting two residences.” As for the reason some sales fall through? People often become emotionally attached to where they live, so they can overestimate the value, delaying and complicating sales. The fix? No matter how rosy an impending sale looks—even if a realtor is telling you it’s a “sure thing”—don’t pull the trigger on a new house before you close the old deal.
Helping Out Adult Children…Too Much
“One of the biggest dangers that I’ve seen with my retired clients is the support of [grown] children,” says Kaplan. Here’s the bottom line: Even couples who are fully ready to retire and have enough in savings likely don’t have enough money to support their adult offspring long term—especially if those adult kids have families of their own. Although retirement expenses will likely stay relatively constant (until health care costs grow in later life), the expenses of adult offspring are likely to increase every year. By jumping in immediately to help when a child loses a job or doesn’t have enough money to buy a first home, you “only delay the inevitable,” says Kaplan. Meaning: That they’ll eventually need to get another job, change fields, move or save more. And if you cosign a mortgage and your child loses a job, you could be on the hook for the entire sum.
Kelly Graves has seen similar problems derail some of his own clients’ financial plans. “At some point,” says Graves, “you’ve got to be selfish. You have to say, ‘I got this kid through college, got them going this far—I have to worry about myself now.’” So, if you see your adult child on a slippery slope, pre-empt the ask for support and tee up a sit-down conversation. Try to be supportive by offering contacts, advice and information while at the same time letting them know that although you’ll always be there with emotional support, you can’t help financially.
Saving for Retirement Too Late in the Game Or…
Here’s a good rule of thumb: Save for retirement even if you think you’ll never retire. “I have never met someone who’s told me they’re sorry they saved as much as they did,” says Chen. Or as early as they did. Those dollars socked away in your 20s and 30s are like a good batch of sourdough starter. They can grow for decades and you can watch the magic of compounding in action. To wit: Take a 30-year-old earning $60,000 a year who puts away 10 percent of her pre-tax income away for retirement—or $500 a month. At 65, assuming a 7 percent annualized return, she’ll have more than $906,000. If she got raises along the way and increased her contributions to match, she’d have much more. But if she waited until 40 to start socking the $500 away, she’d only have $407,000 at age 65. Even if she started with a higher contribution level—say $750 a month, she wouldn’t catch up. She’d hit 65 with just $611,000. The point: Start early. Save often.
…Robbing the Retirement Stash You’ve Built
And, while you’re at it, avoid taking out a loan against your 401(k), too, says Davon Barrett, analyst at New York-based Francis Financial. Sophia Bera, founder of Gen Y Planning, had clients in this situation after incurring high moving costs, and she also sees it with people attempting to pay off credit card debt. The rules for a 401(k) loan stipulate you’ll be paying interest to yourself on the loan in the long run, but there are pitfalls many people don’t consider when they borrow the cash. The money will be out of the plan, which means you miss out on that growth. While you’re paying yourself back, you might not be able to fully fund additional contributions. And—the biggie—if you leave the company for any reason, that loan automatically becomes due within 60 days. If you can’t repay it, it is treated as a withdrawal, which means you have to pay income taxes and a 10 percent penalty.
Retiring Early Without Checking Your Health Insurance Status or Plan B
Like the idea of retiring early? Who doesn’t? But do your research before pulling the trigger—especially if you plan on stepping out of the workforce before you hit age 65 and are eligible for Medicare. “I’ve got clients paying as much as $2,000 per couple per month for health insurance because they retired before they were Medicare eligible,” says Graves. Health insurance can cost top-dollar when your company isn’t taking on some of the cost. Even if you take advantage of COBRA—the program that allows eligible people continued access to their workplace health benefits for 18 months after leaving a job—those prices aren’t subsidized. The law simply makes the benefits available to you, but without an employer’s help, you’ll be shelling out the same amount they spend per individual on health insurance. The fix: Do all the math before you decide to retire to make sure you’re financially ready. AARP has a retirement calculator that can get you started.
Similarly, if you’re retiring early thinking you’ll work part-time or pick up side gigs, but when it comes down to it, you may find it harder than you thought. “You have to have things in place before you step off the conveyor belt,” says Kaplan. So before you step away from your full-time gig, it’s vital to know for sure that you have enough retirement income. (Vanguard has a retirement income calculator that compares what you may have now with what you’ll need.)
Trying to Time the Market
Finally, time and time again, studies have shown that on average, passively-managed index funds trump actively-managed funds. As humans, we like to think we know better—that instinct can tell us where our money will grow the fastest and that our guts will warn us when it’s time to get out. The reality is that kind of overconfidence can set us back when it comes to market returns. Last summer, due to Brexit and election uncertainty, one of Barrett’s clients felt the U.S. market was due for a correction. Despite warnings from advisors, he moved all his money into one account in cash, anticipating he’d put it back into the markets after the correction had happened. He missed out on 15 percent returns in the U.S. stock market last year. “In the long run, you don’t want to put all your eggs in one basket and bet on something that’s uncertain,” says Barrett. Don’t risk your financial future on a hunch—remember you’re playing the long game.
With Hayden Field