Countless studies and data points have revealed that financial hardship is a fact of life for millions of people. But how does this happen – particularly in a world filled with more prosperity than has ever previously existed?
There are many external factors at play. While prosperity has grown tremendously in recent decades, wages haven’t kept up. As a result, when you adjust for inflation, Canadians and Americans aren’t earning a whole lot more than they were in the 1970s despite paying much higher prices for goods and services.
Of course, personal factors have a significant impact as well. In this article, we’ll be exploring the 10 worst financial decisions that keep ordinary people from having any real shot at overcoming the odds. Often, these mistakes don’t even register as such because so many people around us – even seemingly smart ones – make them. Yet, they silently obliterate the seeds of wealth.
10 worst financial decisions people make
1. Neglecting fiscal responsibility in young adulthood
Many young adults seem to believe that money isn’t something they need to get serious about until much later in life. They let their 20s fly by without making any serious effort to eliminate debt, save, or invest. This is a critical error.
You see, money has tremendous potential for those in their 20s with many decades of life ahead. If we assume the market continues to return its historical average of 8% each year, someone who starts investing $500 per month at the age of 20 will end up with $3.15 million by 65. Meanwhile, someone who starts at 30 – just 10 years later – will see their wealth at 65 slashed to $1.36 million.
That’s the power of compound interest. Those who start just a little bit sooner can achieve exponentially greater results.
Perhaps most consequential, however, is the fact that compound interest also works in reverse. Those who sign up for a lifetime of consumer debt in their early 20s will pay exponentially more in interest over the course of their lives than those who wait until they’re older and more financially stable to do things like purchase high-end vehicles.
Lastly, neglecting fiscal responsibility in young adulthood also encourages bad habits. It’s not like people can just flip a switch at age 30 and become masterful with money after spending it recklessly in their 20s. The consequences follow them via a mathematical disadvantage and years of reinforcing bad money routines.
This is why neglecting fiscal responsibility early in life is easily among the worst financial decisions one can make.
How to recover
Whether you’re still a young adult or have recognized your bad money habits later in life, the solution is simple. You need to get serious about money!
Check out this article for a list of fiscally responsible attitudes and approaches to dealing with money. Set a savings target (perhaps $10,000 over the next 12 months) and start handling your salary correctly.
Keep in mind that in order to compensate for the potential you lost by neglecting your finances in the past, you may need to act more aggressively than you otherwise would. If you’re concerned about not being able to meet major goals like retirement, I’d strongly recommend speaking with a financial advisor and creating a formal plan.
2. Spending too much money on cars
While cars are incredibly useful, they also shred money. Everybody knows this. Yet, many people still rationalize overextending themselves by spending way too much money on vehicles.
There are a few ways this mistake manifests itself. Perhaps the most obvious is when someone buys a costlier vehicle than they can comfortably afford, taking on oversized monthly payments and pumping more money into their car than their investment accounts.
Another common vehicle-related financial mistake involves upgrading more frequently than necessary. Many people head back to the dealership in search of a brand new monthly payment as soon as they’ve gotten rid of their old one, even if the vehicle they’re trading in is perfectly capable of being driven for several more years. They’re content with never escaping the debt cycle.
There are so many other ways to waste money on vehicles as well, including:
- neglecting to do research before visiting a mechanic
- ignoring maintenance issues until they become severe
- buying tons of accessories and making excessive modifications
- not shopping around for a low interest rate when financing
- buying a high-maintenance vehicle
How to recover
If you’ve overspent on a vehicle, you can mitigate many of the financial perils by driving it for as long as possible. A reliable vehicle is capable of lasting well beyond its loan term, which means you should strive to own that car payment-free until it breaks down. By doing so, you’ll reduce the average yearly cost of the car and squeeze value out of it.
Of course, not every vehicle is reliable. If you’ve purchased a money pit (like a luxury vehicle with mileage on the higher end), you might want to consider downgrading to something more manageable.
I would highly recommend watching Scotty Kilmer’s videos on YouTube. He’s a mechanic who pumps out tons of content that will help you save money and make sensible vehicle decisions. He definitely steered me in the right direction when I was in the market for a car!
3. Misusing credit cards
Reckless credit card usage is another one of the worst financial decisions people make.
As with the previous list item, people make this mistake in many ways. Among the most common is carrying a large balance. Because credit cards charge such exorbitant interest rates (an average of 17.98% for new accounts, according to WalletHub), this practice costs people hundreds or even thousands of dollars per year.
Many people also make the mistake of spending more than they need to for the sake of racking up rewards points, not realizing these incentives exist to enrich credit card companies rather than consumers. Even people who pay their balances off in full every month fall victim to this trap, leaving them with less money for saving, investing, or even just spending in a more conscious way.
Also impactful are the bad habits that credit card abuse encourages. Millions of people have gotten used to the idea of buying luxuries now and paying for them later, no matter the cost of borrowing. For example, it’s very easy for someone who sees no problem with paying 17.98% interest on their credit card to rationalize financing a luxury SUV at “just” 8%.
How to recover
First, you need to assess the situation. To figure out whether you’re carrying an excessive balance, read this article and consider the solutions I propose. Additionally, read this article for some tips on organizing your finances so you can be more intentional about money.
One key tip I mention in that second article is eliminating high-interest debt. Credit card debt is the perfect example of an obligation you need to obliterate as soon as possible using one of the two methods I suggest.
To add to what I’ve written in those articles, here’s my general view of credit cards.
I think they’re great for covering fixed costs like your telephone bill yet terrible for settings like the grocery store in which you have the potential to spend impulsively.
That’s not to say you should never use your credit card in potentially impulsive situations. Just maintain a budget and track your progress very closely throughout the month to make sure you stay on track.
4. Paying others first
In personal finance, the phrase “paying others first” refers to the habit of failing to prioritize your own financial goals.
People who make this mistake typically only save or invest what’s left after they’ve made their monthly debt repayments and discretionary purchases. As a result, they end up with very little to show for their income.
How to recover
If you’ve been paying others first, you need to make a drastic change. Flip your budget on its head and start with identifying the amount of money you’d like to save or invest (aka “pay yourself”) each month. Fit everything else around that amount.
In this article, I wrote extensively about squeezing as much value as possible from your monthly salary. Every one of those tips will help you avoid making others rich at your own expense.
5. Putting off investing
Here’s another one of the worst financial decisions people make all the time. Some assume they have lots of time to worry about investing (see the first item on this list). Others tell themselves that investing is too risky or meant for people with significantly more money than they have.
The irony is that neglecting to invest is actually the far riskier move in the long run. Why? Well, it all comes down to a little something called inflation. In the United States, inflation eats away 1.2% of the dollar’s value every single year. That’s a large factor behind groceries costing so much more than they used to a few decades ago.
The result is that anyone who keeps their money in cash loses a substantial amount of purchasing power in the long run. They money they set aside for retirement, purchasing a home, or whatever other goal may not end up going nearly as far as they hoped.
Even an interest-bearing account won’t save them from this given that, per the Federal Deposit Insurance Corporation, savings accounts in the United States come with an average interest rate of just 0.05%.
The stock market, on the other hand, produces an average annual return of 8%, which far outpaces inflation and grows investors’ purchasing power.
How to recover
If you have apprehensions about investing, don’t leave those feelings unaddressed. Tackle them head-on by getting informed about how investing works. I wrote up a very detailed explainer on many different types of investing here.
It’s also important to mention that you don’t need a whole lot of money in order to start investing. Check out this article to learn about 18 ways you can get started with very little money.
Once you understand the market and how to invest safely, there’s no real reason to delay. Even if you’re only able to invest $50 per month, it’s progress. The results will likely motivate you to invest much more eventually.
6. Investing recklessly
Investing recklessly is arguably an even worse financial decision than not investing at all. Rather than losing just 1.2% of their purchasing power every year, people who invest recklessly blow up their accounts to the tune of double-digit percentage point losses on a regular basis plus deal with the associated emotional stress.
Practices such as attempting to time the market, using excessive leverage, and going all-in on Bitcoin are classic examples of reckless investing.
The negative impacts go far beyond the person investing recklessly as well. Their friends and family members who aren’t familiar with investing may assume that markets are inherently high-risk and steer clear.
How to recover
In addition to being one of the worst financial decisions people make, this is a very tough issue to address. If you invest recklessly, it’s very possible you’ve scored some big wins at some point.
This is unsustainable, though. Unless you have Warren Buffett-level skills, it’s very unlikely you’ll continue to outperform index investors over the long haul. In fact, if you look at your yearly returns, you may discover you’re already lagging behind thanks to unprofitable trades that cancel out your few big winners.
The solution here isn’t to try and recoup your losses with more reckless investing. It’s to accept that your strategy isn’t working and switch to the tried and true approach (buying and holding good index funds) sooner rather than later.
7. Not maintaining an emergency fund
A whopping 40% of Americans don’t have enough cash to cover a $400 expense, according to the U.S. Federal Reserve. Meanwhile, the majority of Canadians are just $200 or less away from being unable to pay bills, according to an Ipsos poll.
This is an insane position to be in, especially for those who have nothing but their own spending habits stopping them from setting a bit of extra money aside each month for a rainy day fund. In this scenario, it constitutes one of the worst financial decisions anyone could make in terms of potential for damage.
After all, someone who can’t manage to set aside a bit of extra cash over a prolonged period is going to have a very difficult time doing so during a financial emergency. As a result, they often have to take on considerable debt for situations that should’ve been little more than minor inconveniences.
How to recover
If you’re among the millions of North Americans who are just a few hundred dollars away from being unable to make ends meet, I highly recommend reading this article. In it, I discuss a few common reasons people are unable to save or get ahead financially. See which one applies to you, consider the proposed solution, and work towards building an emergency fund large enough to cover between three and six months of expenses.
As with the other worst financial decisions on this list, the sooner you start addressing this, the better. We all experience financial emergencies at various points. We’d be fools to not use the spaces in between those high-stress moments to prepare ourselves.
8. Trying to impress others
Trying to impress others is one of the worst financial decisions in terms of not only monetary damage but sheer pointlessness as well.
Nobody really cares about how much money anyone else has beyond what amounts to, at most, a fleeting curiosity. Yet many people spend hundreds of thousands of dollars over the course of their lives buying cars, clothes, jewelry, and other flashy things they can’t actually afford.
Nobody with any intelligence is impressed by this because they know anybody with a half-decent credit score can portray themselves as wealthy given how accessible credit is these days.
How to recover
The key to recovering from this mistake lies in realizing how irrelevant your financial situation is 99.9% of the people you know. People are far too consumed with themselves to really pay close attention to what you or anyone else has for very long.
By all means, buy nice things you can afford and will genuinely appreciate. I wear a Rolex. Even when it’s hidden under my sleeve (which is most of the time given that I live in freezing cold Canada), I derive enjoyment from knowing I own such a well-crafted item. That’s the only purpose I see in luxury items.
9. Failing to research before making major financial decisions
Here’s another big one. There are entire industries that rely on consumers making no effort to conduct even the most basic bargain-hunting.
Take currency exchange, for example. Many people are content with letting their bank or credit card company handle the currency exchange process whenever they make a foreign purchase or send money overseas.
The problem is that most institutions charge a hidden 2.5% currency exchange fee. People blow thousands of dollars every single year like this, not realizing that much cheaper discount brokers like TransferWise (affiliate link) exist and are very easy to find.
Used car salesmen, telephone companies, and home renovation contractors love this type of person who goes through life, making decisions based on what’s convenient. Such people hand over fortunes in excessive payments over the course of their lives.
How to recover
Never make a purchase without considering whether a cheaper option could feasibly exist elsewhere. If you can’t answer the question with a resounding “no,” hold off on pulling out your wallet and do some research first.
Salesmen will try all sorts of tactics on you. Scarcity is a common one. It’s laughable, too, because nobody needs to make much of an effort to sell a product that’s actually scarce. It’s a ruse.
Here’s a classic example. When I was shopping for a Toyota Corolla, I had salesmen tell me their inventory would probably be gone if I waited much longer to buy.
I gave the first salesman that didn’t pull this trick on me a chance and ended up with a really good deal. To this day, I drive by those other lots and see rows upon rows of Corollas sitting unsold, which is entirely predictable since the Corolla is a mass-produced and very common car.
The moral of the story is that you need to look through the nonsense and shop around.
10. Participating in blatant scams
In addition to being one of the worst financial decisions, this is incredibly cringe-inducing to witness.
Some people never learn after falling victim to get-rich-quick schemes time and time again. Having known several of these people over the years, I’ve come to recognize that their fault is not ignorance. They know what they’re doing is less than legit. Somehow, they just believe they can game the system.
Indeed, a study of pyramid schemes found that overconfidence is a very common trait among participants.
This can have a devastating effect on not only one’s finances but also their reputation. Many financial schemes thrive on getting participants to recruit people they know. I’ve never looked at anyone who approached me with such an “opportunity” the same way again. It’s an instant trust-destroyer.
How to recover
Financial schemes (not all of which are illegal, such as multi-level marketing companies) make a very few select people rich. Unless you’re exceptionally charming and conniving, it’s probably not going to happen.
You’re far more likely to shred your savings and reputation trying to be someone you’re not. No matter how many times this has happened to you, it’s still possible to change gears and do more productive things with your time.
Consider investing in legitimate assets or starting an actual business. Neither of these things will make you rich overnight but they offer much higher chances of success in the long run.
What makes these the worst financial decisions?
The financial decisions I mentioned above have a few common characteristics.
Potential for financial harm
Naturally, terrible financial decisions often cause the people who make them to lose substantial amounts of money. While this damage is often instantly apparent (i.e. with reckless investing), it can also take a while to manifest (i.e. with failing to build an emergency fund).
How easy it is to make them
There’s nothing really stopping anyone from making the mistakes on this list for their entire lives. In fact, these mistakes are often the path of least resistance. It’s very easy to neglect money in your 20s or upgrade your car every five years, for example, if everyone around you is doing the same.
Difficulty of recovering
While very few financial mistakes will ruin you for life, the ones I’ve mentioned require a very concentrated effort to recover from. In many cases, that involves overhauling one’s entire understanding of money and its purpose.
You can recover – even from the worst financial decisions
Even the worst financial decisions don’t have to amount to a permanent derailing of your fiscal progress. By addressing your mistakes sooner rather than later, you can mitigate the consequences and reach new heights in no time.
I hope this article has helped you recognize some of the most common financial mistakes and the best practices for escaping them. For more personal finance tips, check out my other blog posts here.