People are always asking for advice on what to do with their money. But if you really want to get ahead financially, the smarter question is what you shouldn’t do with your money.
7. Borrowing From Your 401(k)
For starters, the money you take out of a traditional 401(k) is pre-tax, but when you pay it back it will be with money you already have paid tax on. Then, years down the line, when you withdraw the money in retirement you’ll owe tax again. I think paying tax once is plenty.
You also lose out on the compounding of that money. Just think about folks who pulled money out of their 401(k) in late 2008 and early 2009: That’s money that wasn’t invested when the stock market staged its epic rally beginning in March 2009. Lastly, there’s the risk that if you are laid off, or just choose to switch jobs, you typically must repay the loan within a few months. Fail to do that and the loan is treated like an early withdrawal; tax is due and if you’re under age 59 1/2 you will owe a 10 percent penalty as well.
6. Investing in Long-Term Bond Funds
Unlike a direct investment in an individual bond that you can hold to maturity and be assured you will get your principal back (assuming no default), a fund has no finite maturity date and most funds are actively traded.
Right now is an especially risky time to invest in bond funds that hold long-term bonds. With interest rates so low, we all know that sometime in the future — even if it’s not in 2012 — rates must rise. When rates rise, the longer the maturity of a bond, the bigger the decline in its price. Remember, bond prices move in the opposite direction of yields. When yields rise, prices drop.
If you own an individual bond you can at least make the decision to hold on until it matures and receive all your principal back. But a bond fund may sell bonds at those lower prices, locking in a principal loss.
5. Co-Signing a Loan
When you co-sign, you are agreeing to be the payer of second resort. If the borrower reneges on payments, the lender has every legal right to come to you for the money.
Even if you are 100 percent certain you could cover the payments, I want you to step back and ask why you are being asked to co-sign. Is it because the borrower has a sketchy credit score and financial history? Is it because the borrower is looking to borrow too much? Those are both signals that you need to say no out of love rather than yes out of fear.
It doesn't matter who the borrower is, you can’t afford to be an accomplice to someone else’s poor decisions.
4. Designating a Minor as a Life Insurance Beneficiary
Benefits cannot be paid to minors. Make this mistake and your heirs will end up in court and have a judge ultimately oversee how the funds are disbursed. It’s easy to make sure this doesn’t happen: Set up a revocable living trust and make the trust the beneficiary of your life insurance. In the same trust you will spell out that the proceeds are to be used for the benefit of your minor (as overseen by your appointed guardian for the child.)
3. Defaulting on Student Debt
Even if you were to fall into extreme financial hardship and file for bankruptcy, you need to understand that your student loan debt will not be discharged in bankruptcy. It is the Velcro of all debts. Even if you aren’t thinking bankruptcy, falling into default can lead to having your wages garnished (that is, the lender gets to take money out of your paycheck to make good on your debt.)
No matter how financially stressed you are, contact the lender and see what options you may have. If your student loans are from the federal government, you have a variety of repayment plans that can reduce your monthly payments, as well as student loan deferment and forbearance during periods of economic difficulty.
2. Buying Variable Annuities
You shouldn't buy these, especially in a retirement account. They're too expensive, plain and simple. Variable annuities tend to be a better deal for the agent than the consumer. I’d much rather you build your own investment accounts through low-cost ETFs or no-load mutual funds. And you should be circumspect of anyone who suggests you buy a variable annuity for a retirement account. You already have the tax-deferral given that it is a retirement account, so why stick a variable annuity — with its own tax deferral — inside a retirement account?
1. Not Having Four Essential Documents
It is the height of irresponsibility to those you love to not have four basic estate planning documents in place:
- A Will
- A Revocable Living Trust
- An Advance Directive spelling out your wishes for medical intervention if you are ever unable to express those wishes yourself, along with a Durable Power of Attorney for Health Care in which you designate who will advocate on your behalf according to what you lay out in the Advance Directive.
- A Durable Power of Attorney for financial matters, that includes an incapacity clause. This will allow the person you choose to step in and make financial decisions on your behalf in the event you become incapacitated.
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