repost­ed from Yahoo Finance
by: Lisa Scherz­er
April 16, 2013

Finan­cial blun­ders are made all the time and every­where – at the gro­cery store, at the bank, in the hous­ing mar­ket, in the stock mar­ket, with your children’s allowance. Some stem from a lack of knowl­edge or aware­ness, while oth­ers are the result of human behav­ior that often works against our own best inter­ests. The worst mis­takes you can make, though, usu­al­ly involve those that seem harm­less but end up impact­ing your over­all wealth.

Finan­cial blun­ders are made all the time and every­where – at the gro­cery store, at the bank, in the hous­ing mar­ket, in the stock mar­ket, with your children’s allowance. Some stem from a lack of knowl­edge or aware­ness, while oth­ers are the result of human behav­ior that often works against our own best inter­ests. The worst mis­takes you can make, though, usu­al­ly involve those that seem harm­less but end up impact­ing your over­all wealth.

1. Spend­ing an unex­pect­ed wind­fall. All of it.

Two-thirds of baby boomer house­holds will like­ly receive some inher­i­tance, with a medi­an amount of $64,000, for a total prospec­tive inher­it­ed amount of $8.4 tril­lion, accord­ing to research pub­lished in 2011 by the Cen­ter for Retire­ment Research at Boston Col­lege. A big chal­lenge for many inher­i­tors, though, is that they can be com­plete­ly inex­pe­ri­enced with mon­ey. And with inex­pe­ri­ence and poor – or no – plan­ning, comes the poten­tial for squan­der­ing a wind­fall.

Amer­i­cans spend their inher­i­tance shock­ing­ly fast, says Mack­ey McNeill, a CPA in Belle­vue, Ky. “When peo­ple get a big amount of mon­ey that they didn’t earn, they feel like it’s so much mon­ey, they’ll nev­er run out,” she says.

McNeill recount­ed the sto­ry of a client whose moth­er had died and left her about $500,000. “By the time she walked in my door, she only had half of it left,” McNeill says. “She paid off some of her mort­gage, bought a new car, donat­ed some mon­ey and bought a big-screen TV for her son” while hav­ing the unre­al­is­tic expec­ta­tion of being able to quit work­ing and pay for her son’s col­lege tuition. “You need to run the num­bers before spend­ing it,” adds McNeill. “If they keep that cap­i­tal and invest it, they can gen­er­ate income for the rest of their lives.”

2. Cash­ing out of your 401(k) when you leave your job

Among work­ers who left their jobs in 2012, 43% took a cash dis­tri­b­u­tion, up slight­ly from 42% in 2010, accord­ing to yet-to-be-released data from Aon Hewitt, a human resources con­sul­tan­cy. And the small­er the bal­ance in the plan, the more like­ly it is that par­tic­i­pants will cash out when they leave. But tak­ing mon­ey out of your plan before retire­ment is going to cost you; you’ll get hit with a 10% ear­ly-with­draw­al penal­ty (if you’re younger than 59 ½) and get taxed on the sum. And pos­si­bly more seri­ous, you lose the earn­ings that mon­ey could have gen­er­at­ed.

Con­sid­er this exam­ple from Aon Hewitt of an employ­ee who cash­es out of three employ­er-spon­sored 401(k)s over 30 years of work­ing and retires at 65. Assume she saved 8% of her pay, got a 5% match per year, earned 3% annu­al salary increas­es on a start­ing salary of $50,000, and earned 7% in invest­ment returns a year. After fac­tor­ing in tax­es, penal­ties and lost inter­est, she’d accu­mu­late $189,000 in her account by age 65. If she didn’t touch the mon­ey at all, how­ev­er, she’d have $872,000 – the cash-outs would have cost this saver almost 80% of her nest egg.

“I’d like to see folks roll over their 401(k) to an IRA upon leav­ing a job,” says Sheryl Gar­rett, a CFP and founder of the Gar­rett Plan­ning Net­work, a nation­wide orga­ni­za­tion of fee-only finan­cial advis­ers. “Rarely does it make more sense to roll the funds over to the new employer’s plan, pre­sum­ing there is one.”

3. Stop­ping con­tri­bu­tions to your 401(k) plan when the mar­ket – or your account – drops

These plans are the main invest­ment vehi­cle that will fund the bulk of many Amer­i­cans’ retire­ments. There’s a rea­son your 401(k) auto­mat­i­cal­ly takes mon­ey out of your check each time you get paid – if it were up to you to set aside 5% of your pay, you’d nev­er do it. Employ­ee par­tic­i­pa­tion in 401(k) plans increased dra­mat­i­cal­ly after the pas­sage of the Pen­sion Pro­tec­tion Act of 2006, which made it eas­i­er for com­pa­nies to auto-enroll their employ­ees, accord­ing to a paper pub­lished by the Cen­ter for Retire­ment Research at Boston Col­lege last year.

The only real rea­son you would shut down your con­tri­bu­tions is if you’ve got enough retire­ment sav­ings already. “I still have peo­ple telling me they’ll stop con­tribut­ing to their 401(k) because it’s going down,” says Steve Bur­nett, CFP and finan­cial advis­er at Han­son McClain, a firm in Sacra­men­to. “And the invest­ments might be fine. You have to under­stand stock prices aren’t sta­t­ic; what you’re hop­ing for is over time, is that you acquire a mass of sav­ings to live off.”

And you’ve heard it before – you’re giv­ing up free mon­ey when you don’t con­tribute to your 401(k): the match­ing con­tri­bu­tion from your com­pa­ny (if they offer it). Say you earn $60,000 a year and your com­pa­ny match­es 50% of your con­tri­bu­tions up to 6% of salary. Stop par­tic­i­pat­ing and you’re giv­ing up $1,500 bonus (if you con­tributed 5% of your salary) or $3,000 (if you con­tributed 10% of your salary).

4. Suc­cumb­ing to lifestyle infla­tion

A 10% salary bump shouldn’t always equate to a 10% increase in your shoe bud­get or upgrad­ing to the prici­er health club. Of course, a splurge is fine, but try to resist the temp­ta­tion to adjust your lifestyle upwards – or suc­cumb to what some pros call lifestyle infla­tion.

Tak­ing a $2,000 vaca­tion is a one-time expense. Mov­ing into an apart­ment that costs $150 more per month is a new and “per­ma­nent” expense that becomes part of your lifestyle cost. If we’re not care­ful about rais­ing the bar on lifestyle costs, we’re like­ly to ramp it up so high that even­tu­al­ly we’ll be unable to man­age the occa­sion­al speed bumps that come our way, says Michael Kitces, a CFP and direc­tor of research at Pin­na­cle Advi­so­ry Group in Colum­bia, Md. “We also end up with a lifestyle that requires an extra­or­di­nary pile of mon­ey to afford in retire­ment,” he says.

5. Using home equi­ty to invest in the stock mar­ket

If you’re a good way through pay­ing down your home mort­gage, and with rates so low (last week Fred­die Mac said the aver­age 30-year fixed rate fell to 3.43% from 3.54%), doesn’t it make sense to take some equi­ty out of your house and sink it into the mar­ket? “I’m get­ting peo­ple who ask about this, say­ing ‘my home price is pret­ty stag­nant – shouldn’t I take mon­ey out of my home and invest it?’” says Bur­nett.

The prob­lem with this approach is that the stock mar­ket is at mul­ti-year highs at the moment – exact­ly the wrong time to enter the mar­ket, as most pros will tell you. Home­own­ers should pay down the remain­ing mort­gage so that, when they leave the work­force, they’re not bur­dened by it. “If you pay X amount on your mort­gage for a cer­tain num­ber of months, you’ll get a cer­tain out­come. If you invest in the mar­ket, it’s uncer­tain you’d make mon­ey,” says Bur­nett. “Most of our clients are retired, and the ones doing well are those who paid down their house and were debt free.”

To read the full arti­cle on Yahoo Finance please click here.