|

7 money stumbles to avoid

We'll show you how to steer clear of the mistakes or change course

Consumer Reports magazine: February 2013

Find Ratings blob logo

Illustration: Joe Zeff Design

Karen Mendelsohn says a simple mistake has made her forever wise to the big impact small oversights can have.

Mendelsohn was a 36-year-old college administrator, and her children were 4 and 7, when her husband, Harold, died of a heart attack at age 40. She soon learned that he hadn’t updated the beneficiary designations on his retirement plan after they married. In fact, the named beneficiaries—his parents—planned to claim the $100,000 account.

To wrest the inheritance from her in-laws, Mendelsohn had to sue to prove her husband had intended to name her as beneficiary. She ultimately got a court order awarding her the money. Mendelsohn now warns everyone she knows to check their beneficiary designations regularly.

“It was a difficult trauma to deal with in the first place, but to have to worry about my kids’ future was scary, awful,” recalls Mendelsohn, now 57 and a resident of Dix Hills, N.Y.

Nobody’s perfect

Everyone makes money mistakes, and some might be unavoidable when people are in financial distress. But missteps or miscalculations can cost you a lot over the long term or inadvertently hurt your family when you’re gone. When Consumer Reports recently conducted a nationally representative survey about Americans’ money habits, we found several common and insidious blunders that could cause significant financial, and sometimes emotional, pain. Here’s where we found Americans are tripping up.

  • Not updating wills and beneficiaries. Eighty-six percent hadn’t updated their wills or other estate-planning documents within the previous five years.
  • Not sharing information with family. In only 30 percent of households did both spouses know major details about the family’s finances and where to find account information.
  • Messing up on 401(k)s. About two-fifths of respondents set aside 6 percent or less of pretax income in defined-contribution retirement accounts, most likely missing out on free employer matches. Ninety-one percent never reviewed fund expenses within their plans, though those expenses play a major role in investors’ returns.
  • Underinsuring. A mere 36 percent of homeowners had purchased extended coverage on their homeowners insurance that covered the full replacement value of personal property. Only 20 percent of survey respondents had umbrella coverage to protect them from liability lawsuits.
  • Not planning for emergencies. More than 70 percent said they didn’t have an emergency fund that could cover three to six months of living expenses; 77 percent had not stored important financial information and contacts in a secure place.
  • Not checking credit reports. Four out of five respondents don’t review their three credit reports at least once a year, though they’re free and indispensable.
  • Mismanaging debt. Almost one-fifth of those surveyed had revolving debt on credit cards of at least $10,000. Of the almost one-quarter of respondents who were in debt for education loans, 47 percent had taken more costly private loans.

If you’ve stepped in one of these potholes, you’re not alone. In a recent online survey of Consumer Reports Money Adviser subscribers, 62 percent reported having made a big financial mistake at some point in their lives. Of those, 63 percent said the error cost them $10,000 or more. Even financial experts strike out sometimes.

But as you’ll see below, you can correct your missteps or at least mitigate the damage they can cause.

1: Not updating your beneficiaries

Mendelsohn’s story may be extreme, but it’s not unique. Eleanor Blayney, a certified financial planner and consumer advocate for the Certified Financial Planner Board of Standards in Washington, recalls an older man whose son died before him. The man never updated his will to include his son’s widow and child—his grandchild. When he died, that branch of the family lost out. Tales of first spouses inadvertently left as beneficiaries on insurance policies or retirement accounts are common.

Eighty-six percent of our survey respondents said they hadn’t created their will and other estate-planning documents or updated them within the past five years. But even if nothing has changed in your life, every year you should check your beneficiary designations in your will, insurance policies, investment accounts, and retirement plans such as 401(k)s, says William Losey, a certified financial planner in Wilton, N.Y. He has seen cases where employers or investment companies have merged or updated computer systems and lost beneficiary designations. “Don’t put the onus on your financial-services company to have the correct data,” he says.

Make sure the beneficiaries you’ve named in your will are coordinated with those you’ve named for other assets such as your retirement accounts and life insurance, says Bernard A. Krooks, an estate and elder-law attorney in New York City and Westchester County, N.Y. “The will may leave everything to the kids equally, but the 401(k) may name one particular person as beneficiary,” Krooks says. “That is the cause of a significant number of disputes after people die.”

2: Withholding information from family

As a retired psychotherapist who also had a CPA practice, George Moskowitz of Bedford Hills, N.Y., has a unique perspective on what can happen when couples don’t share what they know. The widow of one client realized she knew almost nothing about her spouse’s business when he died, not even the name of his lawyer. “He died, and she was left saying, ‘What do I do now?’ ” Moskowitz recalls.

Our survey showed that in only 40 percent of households did both spouses know where to find details of their financial accounts, required passwords, and keys to safe-deposit boxes. In only 30 percent of homes did both partners also share major details of the family’s finances. The death of a spouse who controls the family money can leave survivors struggling to construct the financial puzzle. An easy solution is to designate a safe, file cabinet, or safe-­deposit box to hold all important documents and account-access information.

Communication between generations also can reduce hassles and misunderstandings. Yet just 37 percent of respondents with adult children said they’d told their kids where to find important documents, accounts, and passwords. Two-thirds of folks in their 70s said they’d had that conversation, but a meager 35 percent of respondents in their 60s reported doing so. Fewer than half of individuals with a parent 65 or older had discussed with their parents their wishes regarding power of attorney, management of finances in the case of incapacity, location of the parents’ important documents, long-term-care arrangements, or provisions of the parents’ wills.

Well-meaning adult children who inquire about their parents’ finances risk being viewed as greedy for the inheritance, and parents might refuse to share that information. But adult children stand a better chance of gaining their parents’ trust and helping them make plans if they get their own financial houses in order first. Then, Krooks says, “They can sit down with their parents to say, ‘We’ve just done this ourselves to make things easier for your grandchildren. What have you guys done, and what can we do to help?’ ”

3: Botching your 401(k)

When we interviewed Consumer Reports subscribers who’ve been successful savers and investors for our profiles, a common refrain we heard was to start saving early in life, invest consistently, and put the maximum allowed into a retirement plan. “I contributed 6 percent of my salary to my 401(k), then increased that to 10 and then 15 percent,” says retiree Dan Baeza, 60, of Coral Springs, Fla. “When I got a raise, half would go to our lifestyle and the rest was put away.”

But in our survey, two-fifths of respondents with 401(k) and similar retirement plans said they were investing 6 percent or less of their income, the typical ceiling for getting a full employer match. Six percent had stopped contributing entirely. Less than a third—29 percent—were maxing out their contributions.

Ninety-one percent of survey respondents said they didn’t review their funds’ fees and other expenses. That’s too bad. A 2010 study by Morningstar, the investment research company, showed that low fees were the best predictor of a fund’s future performance. “The only thing that I am absolutely sure about is that the lower the fee I pay to the purveyor of the investment product, the more there will be for me,” says Burton Malkiel, the renowned economics professor and author.

Fortunately, it’s easier than in the past to compare funds’ expenses. As of last year, 401(k) plans are required to send statements to investors outlining marketing and fund-management fees. If, for example, you’re investing in index funds—a strategy we strongly recommend—you shouldn’t be spending more than $2 per $1,000 invested, or about 0.2 percent, on fees overall. Two good choices are the Schwab S&P 500 Index fund (SWPPX), which charges expenses of just 0.09 percent, and the comparable iShares Core S&P 500 ETF (IVV), with expenses of 0.07 percent.

Notably, a large percentage of respondents to our Consumer Reports Money Adviser survey mentioned costly investment errors, such as buying or selling at the wrong time. Heeding Malkiel’s advice—to invest at regular intervals and hold over the long term—is the most surefire way to avoid those mistakes and build wealth in a relatively risk-free way. “People invariably try to time the market,” Malkiel notes. “They don’t put their investments on automatic pilot. That just kills them.”

4: Underinsuring your home and your life

When Hurricane Gustav blew two trees onto the Baton Rouge, La., home of Denise Porter and Richard Hannon in 2008, the two assumed their homeowners insurance would pay to replace the roof and repair two damaged rooms. But their policy paid only the actual cash value of their property—that is, the replacement cost of the property minus depreciation. And they faced repair bills in the “tens of thousands,” Porter estimates. To economize, they’d also failed to get policy features that would cover the cost of bringing the home up to new building standards and provide for inflation in the cost of materials. “We were shortchanging ourselves,” Porter admits.

Only 36 percent of homeowners told us they’d purchased replacement-cost coverage, a more expensive homeowners insurance that provides replacement of your home with like kind and quality materials. And only 20 percent have umbrella coverage against liability claims.

Since settling their claim, the couple sold that property and bought a new home nearby. Now their homeowners policy includes coverage for inflation protection and to rebuild up to code. To reduce their premium, they’ve raised the deductible to $1,000 per incident from $500. They have a separate, state-sponsored wind and hail policy, with a deductible of 2 percent of the home’s insured value when the loss is caused by a hurricane.

The couple also bought federal flood insurance, at about $350 a year, though their home is not considered to be in a flood-prone area. The Federal Emergency Management Agency estimates that more than 20 percent of all flood claims arise outside of high-risk areas.

Two other coverages that should not be overlooked are life and disability insurance. Term life insurance is more economical than other types. Planner Losey says working parents of young children should buy at least 10 times their incomes, but he and planner Blayney recommend talking to a certified financial planner for a more sophisticated estimate. Use an online broker such as Accuquote, SelectQuote, FindMyInsurance, or LifeInsure.com to compare premium quotes.

Your income is your most important asset, but injury or illness could put it at risk. So if your employer offers supplemental long-term group disability insurance, buy it. A supplemental group policy that raises coverage to 70 percent of income from 40 percent could cost you on average $150 to $200 a year, says the Council for Disability Awareness, an industry group.

5: Not preparing for emergencies

Porter mentioned another measure she and her husband have taken. Because both work in relatively fragile businesses—Porter, 42, sells hand-sewn crafts, and Hannon, 48, works for a newspaper—the couple have prioritized saving for a rainy day. Their emergency account holds about a year’s worth of living expenses.

But most Americans don’t save even half that much. Among our survey respondents only 29 percent had an emergency fund that could cover three to six months of expenses. In a period of prolonged unemployment, that cushion could be a lifesaver.

Saving a bit at a time—say, $20 a week—can help build your cash buffer. That money should go into an accessible bank or credit-union savings account.

6: Ignoring your credit report

Consumers can obtain a credit report from each of the three major credit bureaus—Equifax, Experian, and Trans­Union—free through the industry’s official website, at annualcreditreport.com. To most efficiently monitor your credit, we recommend staggering your report requests to one every four months. But our survey showed that more than four out of five people—81 percent—don’t bother checking their credit reports.

Given that identity theft is the fastest-growing crime in the country, we think that’s a mistake. Consider what we heard from a North Carolina doctor who discovered that her office manager had embezzled at least $500,000 from her practice by using, among other ruses, credit cards taken out in the practice’s name. The doctor and her husband later realized that they could have stopped the fraud if only they had checked their free credit reports. But because they hadn’t needed to borrow in years, they never bothered.

7: Mismanaging debt

Focus on retiring your debt by paying more than the minimum due each month.

Credit cards generate among the most expensive type of consumer debt; the average interest rate is about 14.3 percent, according to LowCards.com, a credit-card comparison website. In spite of those lofty costs, almost half of our survey respondents with credit cards said they carry a balance on their cards. Eight percent reported at least one late payment in the past 12 months. Almost one-fifth—18 percent—said they’d accrued a balance of $10,000 or more.

Worse, 13 percent said they paid only the minimum due each month. That’s a strategy that could chain you to your debt for decades. Assuming an interest rate of 18 percent, it’d take 24 years to pay off a $2,000 debt with minimum payments.

To begin to free yourself from that balance, consider consolidating your debt with a home-equity line of credit; rates on ­HELOCs average between 4 and 5 percent, according to Bankrate.com. If you don’t own a home or lack sufficient equity or income to qualify for a ­HELOC, consider transferring your balance to a lower-cost card. Many cards offer 0 percent financing on balance transfers for 12 to 18 months, after which the rate will jump to between 12 and 22 percent. You also might have to pay a fee of 3 or 4 percent of the balance up front.

Focus on retiring your debt by paying more than the minimum due each month. To that end, put the entire amount you’ll need each month to pay down your credit cards into a separate bank account so that you’re not tempted to use it for something else. You can even arrange for the sum to be direct-deposited from your paycheck.

Jim Henry, 70, a retired health-care executive from Jacksonville, Fla., says he began employing his form of debt management 23 years ago. Burned by a bad business deal and sitting on $50,000 in credit-card debt, Henry began tracking his family’s spending to bring their finances back from the brink. Within about four years he had eliminated the credit-card debt—and he hasn’t kept a balance since. Today, he estimates his net worth to be “north of $1 million.”

Just 35 percent of our survey respondents say they have a budget, but maybe more ought to. “When I look back, it helped me keep an eye on where I was financially,” Henry says. “If you just stick to basics and common sense, you can be OK.”

Even personal-finance gurus make mistakes

Expert

Mistake

David Bach, author of “Debt Free for Life” and founder of FinishRich Media

 

I picked up three credit cards and a charge card for a stereo store while in college. I used them foolishly for things I wanted but didn’t really need, figuring I could make the minimum payments. By the time I graduated in 1990, I owed over $12,000. I remember still the head-spinning feeling of opening those bills. It took me two years to pay it all off, and I’ve never carried credit-card debt since.

John Bogle, founder and former CEO of The Vanguard Group

 

When I started working I did what everybody else did back in the 1950s: I got a broker. That was biggest mistake I ever made. I got nowhere. The broker would say, buy this and sell that. Most of the returns were indifferent. It was complicated to report on my tax returns. More than half the time when he told me to sell, I should have bought. I haven’t invested in individual stocks since the 1950s.

 

Clark Howard, TV and radio consumer-finance expert

 

In 1985 I went into a partnership that bought into an apartment complex in Miami. Under the tax laws then, you went into such deals assuming that you’d lose money. You got roughly $2 in tax benefit for every $1 you lost. In 1986 the tax laws changed. The deal went bust and I got hit with a massive tax bill known as recapture. I learned not to make investments just for tax reasons.

Jane Bryant Quinn, personal-finance columnist and author

 

In the 1980s, a neighbor told my husband and me that he was investing in a new jeans company. I loved the jeans. We talked with his partner, looked at his business plan, and invested $25,000. Well, the partner had misrepresented himself, and our neighbor didn’t share some key information. The investors lost everything. We didn’t do our due diligence; we just trusted what we were told.

 

Dave Ramsey, radio personal-finance expert and author

 

By the time I was 26 years old, my wife and I held real estate worth over $4 million. I was good at real estate, but I was better at borrowing money. I had built a house of cards. We went through financial hell, and lost everything over a three-year period. We were sued, foreclosed on, and finally were bankrupt. After that we said we’d never have debt again—and we haven’t.

Michelle Singletary, nationally syndicated personal-finance columnist

 

The worst decision I made was being too conservative when I first starting investing in my company’s 401(k) in my 20s. I took advice from a co-worker who was about 10 years from retirement and very conservative. He made me scared of the stock market, so I put most of my money in bonds. And I didn’t change that selection for years, so I missed out on some roaring times in the stock market.

Eric Tyson, author of “Personal Finance for Dummies”

 

My biggest mistake was investing a few thousand dollars through a precious-metals company, IGBE. It ran ads in prominent publications, which gave it credibility, and smooth-talking people handled the phone lines. IGBE turned out to be a fraudulent business and ended up bankrupt. I learned a valuable lesson—to do lots of homework before investing through any company.

Doing it right: Readers give lessons in building wealth

Kenneth Maltz of Jericho, N.Y., taught instrumental music in public schools for 34 years and retired at 55 with a net worth upward of $1 million. He credits that nest egg to a good pension, diligent saving, and nerves of steel when investing.

“The most important thing was starting to set the money aside at an early age and not skipping a paycheck’s contribution—ever,” says Maltz, 64. “The second was realizing that not spending on a fleeting pleasure would pay off years later.”

Maltz says he started investing in his early 30s. He always salted away the maximum allowable contribution into a tax-deferred 403(b) retirement plan. Knowing he would have a teacher’s pension made it easier to take some risks investing in individual stocks. “What I was good at doing was not panicking when the market took a downturn,” he says. “I always believed that when times are bad and shares are low, that’s the time to buy.”

Maltz spends retirement playing clarinet in bands specializing in klezmer, a kind of Jewish folk music. Musician friends who eschewed day jobs now express envy at his financial freedom. “I had to turn down a lot of music work when I was younger because I was teaching,” he says. “Now I’m in a good position.”

Mary Haskin of Seattle made a lucky bet on her future when she joined Genentech, then a growing biotech company. But she kept the money she made there—and made it grow—through old-fashioned smarts.

“I was the type of person to live below my means and to plan,” says Haskin, 57. That meant always paying at least one extra mortgage payment a year and carrying no credit-card debt. “I made substantial money, but I didn’t need to spend it all,” she adds.

Haskin left a three-year stint as a high-school English teacher to become a pharmaceutical saleswoman. She joined Genentech in 1997. As she climbed the corporate ladder, she gained stock options. Unlike others who cashed in their options, she held on and diversified. Three years ago, she retired with a net worth in the mid-seven figures. She now spends time with her partner doing numerous sports, volunteer activities, and hobbies.

Currently, more than half of Haskin’s money is in fixed-income funds and 16 percent is in stock mutual funds, with 5 to 10 percent more in individual stocks. She invests a small percentage of her wealth in nonfinancial investments, including individual farms in the Midwest. She credits her continued success in part to close communication with her financial planner.

Bob Berkowitz of Crescent City, Calif., has found a way to spin gold from vinyl siding. The 72-year-old rents out several manufactured homes in his rural town and surrounding areas. He has fixed up and sold many more.

“Investing in rental properties is way different in rural areas vs. metropolitan areas or big cities,” he says. “You have to make sure all parties are winners, because you are going to run into your renters everywhere.”

Berkowitz says manufactured homes built after 1985 are sturdy and easy to rehab. He won’t touch a property that can’t generate cash flow from the first day he rents it. He also fixes up and resells distressed and foreclosed houses.

Eighty-five percent of Berkowitz’s net worth and income derives from real estate, he estimates. Social Security and an investment in a research company make up the rest of his income. “I gave up on stocks, bonds, mutual funds, and other investments that are managed by others a long time ago,” he says. “I found out that the best manager of my money is me.”

   

E-mail Newsletters

FREE e-mail Newsletters!
Choose from cars, safety, health, and more!
Already signed-up?
Manage your newsletters here too.

Money News

Connect

and safety with
subscribers and fans

Follow us on:

Cars

Cars New Car Price Report
Find out what the dealers don't want you to know! Get dealer pricing information on a new car with the New Car Price Report.

Order Your Report

Mobile

Mobile Get Ratings on the go and compare
while you shop

Learn more