LIVING DEBT-FREE IS A common goal, but it’s no easy feat if you’re living paycheck to paycheck. In fact, in your effort to steer clear of debt, you could make mistakes that make it more challenging to reach your goals. So if you’re striving to eliminate debt – or avoid it altogether – don’t fall for these common pitfalls.
Here are common mistakes to avoid to live debt-free:
- Skimping on saving.
- Giving up on investing.
- Ditching credit cards.
- Neglecting insurance.
- Overspending.
- Forgetting to create and stick to a budget.
Skimping on Saving
While nobody wants to be saddled with debt, paying off the money you owe at the expense of putting money aside in a savings or retirement account isn’t an effective long-term strategy, says John Bergquist, senior founding partner at Common Sense Financial, a financial planning firm in South Jordan, Utah.
“I know some talking heads in the financial world preach against this and recommend you put everything into the debt plan, but there are dangers in doing this,” Bergquist says. If it takes a long time to pay off your debt, Bergquist points out that you’re missing out on compound interest and all that it can do for a retirement account. And, if nothing else, a savings account can help keep you out of debt, he says. “We need the savings to pay for all those unexpected expenses along the way, so we don’t add to our debt repayment plan and stay the course,” Bergquist says.
Zach Ashburn, president of Reach Strategic Wealth, a financial planner in Winston-Salem, North Carolina, also stresses the importance of having a well-stocked emergency fund. “Whether you’re getting out of debt or living without using debt, your emergency fund is the buffer between you and new debt,” Ashburn says.
Most experts also recommend setting up automatic transfers from your checking to your savings account to build an emergency fund. Experts also suggest putting the money aside in a different bank savings account to allow your balance to gradually grow each month.
Giving Up on Investing
If you’re mired in debt, likely the last thing on your mind is investing. However, too many people focus on not getting themselves into debt or more debt and forget about building wealth, Ashburn says.
“When your primary goal of living debt-free is both ambitious and tied to a vision of freedom, it can be easy to get tunnel-visioned,” Ashburn says. He advises building savvy investment habits into your financial plan.
Ditching Credit Cards
If you’ve had bad luck with credit card debt, you may be tempted to swear off credit cards forever. While you may want to ditch your credit card, paying with plastic can be an effective way to bring up your credit score. Ultimately, a high credit score is the best way to get low-interest loans on a house and a car.
In short: Use credit cards responsibly, such as never buying more than you can afford to pay off every month and getting into the habit of not carrying revolving debt. That way, if you need to buy a home or a car or take out a personal loan, you should be able to get one with a low-interest rate. If you do have credit cards and are trying to get your debt down, remember to pay more than the minimum monthly payment; if you only pay the least you need to pay, you’ll remain in debt far longer.
Neglecting Insurance
Insurance is designed to keep you from paying exorbitant costs to fix a problem if something goes wrong – and then going into unnecessary debt. And that’s a real concern. For instance, according to an American Cancer Society report released earlier this year, 137.1 million Americans had medical financial hardship in the last year.
But it isn’t just medical debt you need to be concerned about. If you’re underinsured and you get into a car accident, you could end up spending a small fortune to replace your vehicle. That could be very problematic, especially if you are already in debt.
“One of the common mistakes I see among people who strive to live debt-free is that they lack adequate insurance coverage,” says Henry Hoang, a certified financial planner and founder of Bright Wealth Advisors, a registered investment advisory firm in Orange County, California.
“Being frugal is a key trait to living debt-free for most, but when taking it too far at the expense of not properly managing risk, it can backfire,” Hoang says. “Whether it be personal, auto or commercial lines of insurance, people who are debt averse may commonly skimp on their coverage amounts or opt not to purchase important policies to save on premium dollars. Unexpected illnesses or accidents can set families back beyond what their liquid savings can cover.”
Disability insurance or business interruption insurance might also be important to have, Hoang adds. He says that he had a client who was a dentist with her own practice. She had a ski accident and injured her arm and couldn’t work on patients for a few months. She was properly insured and was able to heal without seeing her practice implode. After that, Hoang says he began talking with every client about the importance of managing risk and being properly insured.
Overspending
You don’t have to constantly cut corners to avoid going into debt, but you do need to curb impulse purchases. According to a survey commissioned last year from Slickdeals, a coupon and deals website, respondents reported spending an average of $450 a month on unplanned purchases. That comes to $5,400 a year. Avoid overspending by practicing self-discipline, creating a concrete spending plan and pinpointing other ways to reward yourself.
Forgetting to Create and Stick to a Budget
Bergquist says that people who put all of their money into the debt and don’t budget for anything else, “inevitably have some sort of a hiccup on their debt repayment plans and incur unexpected expenses.”
As for sticking to a budget, many experts endorse the 50/30/20 rule. Here’s how it works: Once you receive your after-tax income, spend half of your pay on things like housing, utilities, health insurance, car payments and groceries. About 30% of your paycheck should go toward things you want but don’t need, like streaming entertainment services, and 20% should go toward savings and paying off debt. However you budget, it doesn’t matter how you split your expenses up, as long as you come up with a system that works for you.
If you have unexpected expenses that you then have to pay for, and it hurts you financially, Bergquist says that you might then get discouraged. “So often they throw their hands in the air and exclaim, ‘I will never get out of debt,’” The danger, he explains, is that some people then stop trying to get out of debt.
Bergquist also endorses keeping something in the budget for fun and some of the extras in life. “If we, as human beings, were just computers and it all came down to simply unemotional numbers on a paper, then focusing only on a debt plan and then adjusting it as things change might just work,” Bergquist says. “However, we need the little successes along the way to help encourage us to stick with the plan until it comes to fruition and we are out of debt.”
In other words, if you want to be debt-free, like working toward any ambitious target, you need to do it in moderation and work incrementally, making small but significant steps toward concrete long-term goals.
