While having a steady career or job will do wonders for building a sense of financial wellbeing, it won’t be enough to get you to a point of financial wealth. The wealthy know that there is so much more to attaining wealth than meets the eye, and it takes discipline and knowledge to gain a stronghold on your financial wellbeing.
There are a variety of common pitfalls that haunt individuals as they attempt to work their way toward wealth. Avoiding these five killers of wealth could be the difference between the wealthy lifestyle you dream of, and having your finances fall apart quicker than you can imagine.
Financial illiteracy
When it comes to your finances, knowledge is power. Furthermore, everyone’s financial situation is different and unique. What works for some might not work for others. In order to build wealth, you will have to do your research and go through the process of investing, budgeting, and accounting on your own. This hands-on experience will teach you what works and be invaluable for years to come.
There are a few ways you can start. Create a do-it-yourself budget in excel to start tracking your daily expenses. There are even some good templates online which can help you get started. Read a few books on investing to learn about different asset classes. The Intelligent Investor and A Random Walk Down Wall Street are two great places to start.
You can even start a side hustle. This process will help you better understand how to keep accounting records and be meticulous about your financial process. Sites like UpWork allow you to pitch your skills to potential clients all over the world.
Lastly, ensure you understand your local and national tax laws. Doing so could completely change how you view financial decisions. In some cases, it may be advantageous to take a loss on an investment, while in other cases it may make more sense to wait and sell an investment in the coming year, for example.
No emergency fund
A tree branch falls on your car during a rainstorm. Someone smashes your front window trying to break into your home. In life, these unexpected occurrences are bound to happen. Therefore, you should always be prepared with an emergency fund for unexpected expenses, as it’s difficult to pay for such unpredictable expenses with just your monthly income.
Without an emergency fund, you have no way to pay for the things that can come up at any moment. Instead, you may have to take out a high-interest loan or max out your credit cards just to get by, which could lead to a cycle of debt that is hard to recover.
There are many different opinions as to the size of an emergency fund. Some say it should be equal to three months of your living expenses, while others believe that starting out with a smaller emergency fund is fine. This is a personal decision and should be made taking into account all of your assets and liabilities. The more assets you have (car, house, etc.), the more that could go wrong, and therefore the bigger your emergency fund should be.
Debt
Contrary to popular belief, debt isn’t all bad. But debt should only be used strategically and for a specific purpose. For example, if you are looking at attending a specific university program, you may need to take out a loan to pay for the education. There is nothing wrong with this kind of debt as it’s likely the gain from your income as a result of your completed education will offset any debt incurred.
However, taking on too much debt could cripple your financial life before it even gets off the ground. It is nearly impossible to accumulate true wealth with mounting debt from mismanaged financial decisions. This is because compounding interest on the unpaid debt will cause you to pay the price over your lifetime.
Unnecessary debt most often comes in the form of credit card debt. It is easy to take on more debt with the simple swipe of a card, but don’t be fooled by the allure of buying an entirely new wardrobe and paying for it later. Credit card debt comes with extremely high-interest rates and has been known to ruin the lives of many people. If you are going to take on any sort of debt make sure it is a well-planned financial decision.
Instead of making interest payments for years on accumulated debt, you might want to think about how to earn that cumulative interest for yourself, and help grow your wealth significantly over time.
Not investing
Let’s say you’ve taken care of your emergency fund and paid off your debts, what’s next? You could simply take all of the money you earn, put it in a bank and forget about it, hoping you will earn enough over your working life to retire someday. This thinking is not only wrong, but can be detrimental to your long-term goals.
It has been proven time and again that the only way to get wealthy is to invest. And, unlike what you may have been told, you don’t need a lot of money to get started. One of the biggest reasons investing can be so advantageous is because of compound interest. Unlike compound interest that will cause you to make significant payments to pay down your debt, compound interest on investments is what can lead to significant financial gains.
Compound interest is a way to earn interest on top of the interest you have already made. By reinvesting your interest back into an interest-bearing account, you will receive interest on your new, higher balance. To highlight how important this principle is, imagine you put €10,000 into an investment account which is doing well and earning you 10% interest per year. In five years, your account balance would be €16,105.10. However, if that same account compounded interest monthly, your account balance at the end of the same period would be €16,453.09. That is a difference of €347.99 just with the use of compound interest! To learn more about compound interest, you can use one of the many compound interest calculators which will calculate your potential returns when utilizing compound interest.
One way to ensure you invest is to take a portion of each paycheck and set it aside for investment. Start small, maybe only a few euros a month, and work your way toward more if you can afford it.
Speculation
Don’t confuse speculation with investing. The latter involves making calculated risks based on research and gathering information. However, speculation is akin to gambling and uses money in a way that completely leaves your fate up to chance.
One of the biggest speculative plays out in the world today is cryptocurrencies. As the price of cryptocurrencies like Bitcoin skyrocketed in 2017, people with no knowledge of the new technology began investing hoards of money, afraid they would miss the boat. Some even took out loans just to invest in this new asset class. After peaking above $20,000, Bitcoin crashed, falling lower than $4,000, and losing many speculators millions of dollars as a result.
Another example of speculation was right before the financial crisis of 2008. Many people bought homes believing, incorrectly, that home prices would always rise in value. This was a speculative decision based on hopes and dreams. The result was a housing market that tanked and many people losing their homes
Do yourself a favor, whenever you have a hunch or are afraid of missing out on a speculative play that everyone is talking about, take a step back and think about it. Then check the data. If it sounds too good to be true, it probably is.
Take control of your finances
Attaining wealth isn’t easy. It takes hard work. You must dedicate the time to learn the best strategies for growing your wealth, while avoiding the common pitfalls that most people encounter.
Avoiding the aforementioned killers of wealth is a great start on your road to financial freedom.
