Erika writes in with a great question that grew beyond a normal mailbag entry:
Why do you think people get into financial problems to begin with besides the obvious “not enough income”? The easy answer is temptation to buy stuff but I think there’s more going on than that.
I’ll be honest: Erika hits on the two biggest reasons I can think of for why people get into financial problems. Insufficient income is definitely one issue, but at the same time, I think there’s a lot of spending that’s done as a result of misplaced priorities, mostly because people value the short term a lot more than the long term.
In fact, assuming there isn’t anything that can obviously be done to raise one’s income or bring in some more money, the number one reason for financial problems is misplaced priorities. People spend money on things that should be a lower priority, and then find themselves struggling to pay for things that should be a higher priority.
This comes back to the “important” and “urgent” dichotomy that serves as a really powerful time management insight. Everything you need or want to do in a day fits into one of four categories – it’s either important and urgent, important but not urgent, urgent but not important, and neither important nor urgent. Signing up for your 401(k) is important but not urgent. Taking your sick child to the doctor is important and urgent. Answering a ringing phone is urgent but not important. Channel surfing is neither urgent nor important.
We all do things each day that fit into each of those categories, but the biggest mistake we make is giving too much credence to things that are urgent but not important (answering a phone call) and too little credence to things that are important but not urgent (signing up for a 401(k)).
We do the same thing with money. There are things that are important and urgent, like paying the heating bill. There are things that are important but not urgent, like funding an emergency fund. There are things that are urgent but not important, like buying that thing you want that’s on sale. There are things that are neither urgent nor important, like buying a regular-priced coffee at the kiosk at the store. Obviously, the important and urgent stuff comes first for everyone, but where people slip up is that they often put the “urgent but not important” purchases above the “important but not urgent” expenses.
I see some especially egregious examples of that pop up all the time in reader stories and in the financial lives of people I know and read about, and I’m going to detail five of them that I see happening often, where something that’s really important but not that urgent is overlooked for something that screams for your attention but doesn’t really matter.
Before I dig into these examples, though, I want to point out that everyone has different priorities and different situations in their lives. Something that I describe as a misplaced priority here might not be in your own life. Rather than viewing these as a checklist of misplaced priorities, instead look at these as areas of your spending to which you should give some serious thought in order to ensure that your priorities are in a good place.
Let’s dig in.
#1: Overprioritized Entertainment Spending
Over and over again, I see people with monthly budgets that include literally hundreds of dollars in entertainment spending that’s just included as a default assumption without really considering what it’s doing to their overall financial picture.
A cable subscription is pure entertainment spending. A Netflix subscription is pure entertainment spending. The same for Hulu and Amazon Video and Spotify and Pandora and YouTube Red and on and on and on. Home internet is largely used for entertainment, too. A large data plan is almost always used for entertainment; very few people need more than a gigabyte or two a month for non-entertainment purposes.
There’s nothing wrong with spending some of your time on entertainment, but there are many sources of free entertainment out there. Check out books and DVDs and audiobooks from the library. Turn on a radio. Hook up an over the air antenna to your television. Participate in a sport instead of just watching it. Go on a walk or a hike. There are literally infinite ways to entertain yourself for free, so spending hundreds a month on entertainment is kind of silly when you’re struggling to make progress toward any of your life goals.
Kill off some of those entertainment bills – or, better yet, all of them. Learn how to find sources of free entertainment and then use that money to fund some of the other misplaced priorities.
#2: Underprioritized Emergency Fund
If your financial house would fall apart if you missed a couple of paychecks, then you’ve drastically underprioritized having an emergency fund. This is even true if you would be able to survive through the use of credit cards.
As we learned during the recent federal government shutdown, a lot of American families are just a paycheck or two away from crisis. In fact, 78% of US workers live paycheck to paycheck. If they were to miss a single paycheck, there would be significant financial distress in their life.
That’s an enormous problem on many fronts. Emergencies are going to happen. Winter is always coming. If you are so woefully unprepared for an unexpected job loss — or illness, or automotive failure, or some other common issue — that such an emergency would push you into a cycle of high-interest debt or to start missing payments, then that problem is compounded both financially and in terms of personal stress.
The solution is simple, but it’s one that many people overlook and bypass while spending money on less important but more urgent things (like, say, entertainment). All you need is an emergency fund, which is just cash in a savings account somewhere that you can tap if things fall apart. (If you can’t get a savings account, then it’s cash stowed away somewhere safe.)
It’s easy to set up, too. Just have your bank start transferring a small amount each week from your checking account to your savings account. $20 a week turns into $1,000 in your emergency fund after a year, which can help you with a car problem. $50 a week turns into $2,500 at year’s end, which can get you through a month without a job. Just leave that transfer in place permanently.
Then, when things go bad in your life, tap that emergency fund. You won’t find yourself going into emergency credit card or payday loan debt. You won’t find yourself missing payments. You won’t find your life majorly disrupted. You’ll keep rolling through those inevitable bad things that life will eventually throw at you.
#3: Overprioritized Food
By “food,” I don’t mean the basic staples. I mean foods that go beyond basic healthy and tasty meals and basically any beverages besides water. That absolutely includes meals eaten or prepared outside the home. That includes junk food. That includes soda. That includes alcohol.
The most financially sensible diet is one where you’re eating healthy, inexpensive staples for most meals and drinking just water. Healthy, inexpensive staples include things like rice, beans, peanut butter, pasta, oatmeal, chicken, eggs, fresh produce that’s on sale, flash frozen vegetables, and so on. Those ingredients, along with just a handful of herbs and spices, can be remixed into almost infinite delicious meals. While it’s a bit presumptuous to assume that all meals should stick to that dietary backbone, it does make sense to have most of your meals stick to that, saving other meals for genuinely special occasions such as social gatherings.
However, many people live on a regular diet that’s very expensive and nothing like that. Most Americans eat at restaurants and get takeout or delivery multiple times a week. They eat tons of prepackaged foods (read: expensive), meats, alcohol, and so on. Those items are not only expensive in the moment, but they have a long-term health cost, too. There’s no problem with eating them occasionally, but the backbone of your diet – what you eat for most meals outside of special occasions – should be made up of healthy, low cost staples.
What if you don’t have time? Learn how to use a slow cooker. Do some meal prepping on the weekends. Learn how to actually cook efficiently. Not only that, a lot of those things are very quick to cook anyway. It takes 10 minutes to boil pasta.
Switching to having most of your meals made up of basic staples like those listed earlier isn’t a big life change, but it is a huge financial shift that can free up hundreds of dollars a month. It just takes a reboot of the routines that many people think of as normal.
#4: Underprioritizing Debt Repayment
Every time you choose to spend money on something else other than rapidly paying off a debt, you’re essentially leaving that money as part of the balance for the remainder of the loan.
Got a credit card balance that won’t be zeroed out for the next five years that charges 30% interest? If you spend $50 frivolously now instead of making an extra debt payment (or add $50 to your credit card balance), that $50 sticks around for five years, accumulating and compounding 30% interest each year. That adds up to $185 in extra debt payment you’re going to have to make at the end to pay off that debt. A night on the town turns into half of your paycheck.
Once you have your absolute necessities taken care of, you’re building an emergency fund, and you have just a little bit more set aside for some spontaneity in life, you should be prioritizing debt repayment, particularly on your high-interest debts. The financial impact debt has on your daily life is enormous, and the financial benefit of early payment (in terms of the reduction in interest you’ll pay) is enormous.
- Read more: In What Order Should I Pay Off My Debts?
#5: Overprioritizing College Savings
This is a lesser issue, but it’s still an important one: If you’re saving for your child’s college education but not saving for your own retirement, you’re making a financial move that will end up putting you at a serious disadvantage while not giving your child as much of a boost as you think.
A much better approach is to adequately save for your own retirement using a Roth IRA, from which you can withdraw the balance for your own needs at any time without penalty. Then, have your child go through the financial aid process and see what their situation is and their needs are, then you can supplement that financial aid package if needed with money from your Roth IRA or other sources.
Putting money into a 529 college savings plan is helpful, but it locks the money down solely for their educational use. If your child chooses to go to a trade school or earns a lot of scholarships, that money could have been used to help you retire easily. In effect, 529 contributions – if you don’t already have adequate retirement savings – means that you’re locking down your money for one purpose when flexibility would be much better.
Saving for your child’s college education is great, but given the flexibility of student financial aid, you should allow that process to happen before making big decisions with your money. Put money into a Roth IRA for yourself so that you’re securing retirement for yourself no matter what and then can make the choice later, when you see how your child’s educational situation turns out, to use some of that money for their education.
Obviously, the best of all worlds is to save adequately for your own retirement and contribute to your child’s 529, but if you’re constrained by finances to have to choose between the two, prioritize your own retirement savings.
In my view, someone who is carrying a credit card balance month over month and doesn’t have an emergency fund while going out to eat multiple times a week and carrying a cable bill is creating their own financial prison. That’s a cavalcade of misplaced financial priorities, and they’re adding up by the thousands each year, and yet it’s a common story for many Americans.
If you take one lesson home from this story, it’s this: Think seriously about the relative importance of what you’re choosing to spend money on and what you’re not. I can’t define for you what’s important in your life and what isn’t, but I can say with some confidence that really thinking about what you find to be truly important will offer some valuable financial direction for you.
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