Common Financial Mistakes

Another great question David Chilton, The Wealthy Barber, asked me on his podcast is what big financial mistakes I see people making.  I’ll discuss two mistakes I see mainly among working-age people and two more specific to retirees.

Buying expensive cars and trucks

Paying $1000+ per month on car loans for the rest of your life isn’t a sensible financial move for most people.  You might need a car, but you don’t necessarily need such an expensive car.  In a moment of weakness and excitement, you sign the papers on that great car.  That sets up a cycle that’s hard to break.  You’ll be rolling one car loan into another.  The debt will keep growing and last for decades.

I used to tell people to pay cash for cars.  I still think this is good advice, but people just blink now when I say it.  At the very least, think about the life burden your car payments will create and choose a car that fits your budget.

Buying a house that is too expensive

This is an emotional subject.  Young people aren’t to blame for the huge increases in house prices that have recently started to reverse.  But young people are the ones feeling the pain.  The number of forced sales is starting to increase.  The people who bought thinking they had to jump in or prices would just run away from them are learning that house prices can drop.

Taking on a mortgage you can’t handle and hoping to refinance as your home appreciates only works as long as prices keep rising fast enough.  This plan is certain to blow up eventually.  At some point, you have to be able to make mortgage payments without the help of additional loans.  Keep this in mind before you buy.

People renovate too much.  Necessary repairs are one thing, but fancy new kitchens and bathrooms are expensive and unimportant.  Dated fixtures and cabinets work as well as new ones will.  A carefully thought out plan to improve function can be sensible, but going into debt to make things prettier is senseless.

Retirees overspending

The retirees who overspend tend to be those with modest pensions and savings.  They want to continue to live life as they’ve always lived it in the same home, but they don’t have enough income and assets to get by for the long term.  They’re fine most of the time paying the bills that come in every month.  But less frequent costs make them dip further into their savings.  It might be a car repair, home maintenance, helping an adult child, or some other demand.  That $100,000 they started retirement with quickly becomes $50,000, and keeps dropping.

Maybe they’ve got a small workplace pension that isn’t indexed to inflation.  Prices keep rising.  At first there isn’t enough money to make bigger home repairs, but it gets worse.  They don’t want to leave their homes, but there just isn’t enough money to stay.  They can see that they’re in trouble.  They’re worried and embarrassed.

I've painted a picture where the problems don’t seem like the retirees’ fault.  But the truth is that they needed to see this coming sooner to put the brakes on spending before it was too late.  Some people really do face unforeseeable challenges, but for many, the path is predictable.  If you’re going to have to make a lifestyle change or move to reduce spending, it’s better to do it sooner rather than later.

Retirees underspending

The retirees who underspend tend to be those with substantial savings (perhaps $500,000 to a few million), but they fear that they’re in the overspending camp.  They were good at saving their whole lives, and they’re not good at reversing course and spending their money.

This is the type of retiree good financial advisors see frequently.  The fact that they have a lot of money is what made them desirable clients.  Overspending retirees are less visible to advisors and the financial media.  It’s the good savers who interact with online financial content, and so that content caters to them.

Good savers often retire with big RRSPs, maxed-out TFSAs, some non-registered assets, and perhaps some sort of pension.  They used to have working income, and now they see a substantially reduced income.  They’re comfortable spending the dividends from the non-registered assets, and perhaps the non-registered capital, but they can see this isn’t enough.  They take CPP and OAS as soon as possible, but the income still isn’t enough.

They try to live as frugally as possible to leave the RRSPs and TFSAs for later.  They don’t realize it, but they’re living small now so they’ll be rolling in cash when their forced RRIF withdrawals start.  They’ve got everything backwards.  When I try to explain the idea of spending some RRSP money in their 60s to have a decent lifestyle for their whole retirement, they look horrified.  They’re not doing that.

When I try to explain that they should delay taking CPP and OAS until they’re 70, all they hear is that they should live even smaller.  The RRSP meltdown strategy that increases spending for their whole retirement just sounds crazy to them. 

Every situation is different, but the common theme of living small early in retirement and making the wrong moves with RRSPs, CPP, and OAS, plays out every day.  These people need to take a long-term view of their retirements and consider all the options for which order to spend assets.