The United States has one of the highest median incomes in the world, yet we rank near the bottom of developed countries when it comes to savings rate at just 3.6%. The reason for that is simple: we consume more than almost any other country, choosing satisfaction today over saving for the future. You don’t have to live like most Americans, and you can choose to delay gratification to the future and save for a more beautiful tomorrow. Here’s some of the biggest traps to avoid if you are trying to build wealth.
1. Living at or above your means
The biggest reason why most Americans have difficulty saving money is they are living at or above their means. If you are living paycheck-to-paycheck or spending more money than you make, there is obviously nothing left to save. If you know you make enough to be investing for retirement but struggle with discipline, you need to reprioritize your finances.
Instead of saving what is leftover every month, pay yourself first. This means invest out of the top of your paycheck instead of the bottom. It is difficult to save money when we don’t treat it like a priority. Instead of creating a budget that allocates 100% of your gross income, determine how much you can comfortably invest first and then budget the remainder. For example, if you are able to invest the recommended 25% for retirement, put that money away first and budget the remaining 75% of your income.
2. Credit card debt
Credit card debt is one of the biggest roadblocks to building wealth in this country. About half of all Americans have carried a credit card balance for at least a month over the past year, and for those with credit card debt, the average balance is $7,886.
Credit card debt is extremely harmful to your finances for a few reasons. To start, it does not represent a growing asset or, in most cases, even a useful asset. Mortgage balances are offset by the value of your home. Car loans are offset, at least partially, by the value of your car and the utility of your vehicle. Credit card balances are offset by…the new television in your living room?
The interest rate on credit cards is significantly higher than other types of debt since they are unsecured loans. The average credit card interest rate currently sits at 25.28%. That means for every $1,000 in credit card debt, you’ll pay $252.80 per year in interest. Or if you have balances totaling $10,000 at the average interest rate, you’ll pay $2,528 per year in interest alone.
If you are able to use credit cards responsibly without overspending, there is nothing wrong with them. But if you are prone to overspending or already have credit card debt, it may be best to avoid them altogether.
3. Student loans
Student loans can be a means to obtaining a higher-paying job and are well worth it for many students, but unfortunately a large portion of young adults have more student loan debt than they can handle. The best years for saving and investing coincide with when many are going to college and taking out loans, which is why student loans can be so dangerous: they take away from some of your best investing years. The average student loan payment is about $434 per month, with borrowers taking 20 years to pay off their loans.
If you were to obtain a good-paying job without going to college and had the ability to invest that $434 per month starting at age 20, by age 40 you would have $329,566 saved for retirement, assuming a 10% rate of return. If you let that money grow for another 25 years, to age 65, you would $3,973,560 – without saving another dime. If you look at the total cost of college instead of the average student loan payment, the true opportunity cost of a college degree is just over $10 million.
With numbers like that, surely it doesn’t make sense for most people to go to college at all, much less take out debt, right? Despite the opportunity cost of attending, college is still very worth it for many students. I crunched the numbers and found that, for college to be “worth it,” your degree would need to increase your salary by at least $14,640 per year (based on the average cost of attendance; if you attend a more expensive or less expensive school, the math changes). Those with a bachelor’s degree make $40,500 more per year, on average, than those with just a high school diploma. We can likely say that most who attend college are probably making a wise decision, but that doesn’t mean that going to college – or taking out student loans – is the right decision for you.
If you are able to obtain a good-paying job without going to college, that changes the equation. If you would need to take out a significant amount of student loans to graduate, that changes the equation. If the expected salary of your degree is below average, that changes the equation. To determine if college is worth it, weigh your options carefully. If you must take out student loans to graduate, we suggest keeping the total amount of debt below your expected first-year salary after graduation.
4. Expensive cars
Expensive vehicles can be extremely damaging to your finances, and this includes not only sporty convertibles that cost more than you make in a year, but unreliable jalopies that cost more in maintenance and repairs than they are worth. For such an impactful financial decision, buying a car is often made impulsively and without much thought. If you buy a car at a dealership, everything is stated in terms of monthly payment. Those heated seats will only cost you an extra $35 a month! And why wouldn’t you add the extended warranty, it only adds $57 per month to your payment.
It is best to pay for a car in cash if you have the ability to do so. Vehicles are quickly depreciating assets, and will drop by around 20% in value the second it is driven off the lot. Not everyone can pay for such an expensive asset in cash, and would often be better off financially spending a bit more on a reliable vehicle rather than looking for a cheap car they can pay for in cash. We created our 20/3/8 rule to help you determine how much car you can afford without negatively impacting your finances. The rule is simple: when buying a car, put 20% down, pay it off in 3 years or less, and make sure all of your monthly car payments are no more than 8% of your gross income.
We created a car affordability calculator where you can run the numbers yourself to see what your price range should look like.
The United States is a very wealthy country. Our median income is one of the highest in the world, and most of us are fortunate enough to have the resources to comfortably pay for our basic needs like housing, transportation, and food. Not everyone has the financial ability to put away a significant amount for retirement, but a large portion of the country does. Unfortunately, many choose to consume rather than save and fall into one (or several) traps that keep them from building wealth. If you can live differently than most of your peers by spending less than you make, you will have the ability to live differently in retirement, which can mean spending more, retiring early, and living life on your terms.
