Financial Mistakes That Could Haunt You Forever

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© Courtesy Investopedia

After the sudden drop in the Dow this time last year, many investors were left to wonder what else could happen to deflate their savings and investment portfolios. We came up with a list of some of the scariest -- and potentially most costly -- financial mistakes you could make. Take steps now to ensure that you don't lose money by making some of these big, bad choices.

Not Rolling Over Your 401(k) Savings

If you leave a job and opt to take the savings you have accumulated through your employer's 401(k) plan, you need to roll it over into a qualified investment vehicle (i.e. a new employer's 401(k) or 403(b) plan, an IRA, etc.) within 60 business days or you'll have to pay at least 20 percent in income tax on the funds as well as an early withdrawal penalty of usually 10 percent. This is one mistake that can quickly eat up a big chunk of your retirement savings.

Living Off Credit

If you can't make your regular monthly payments on your income and are using credit cards to meet your financial obligations, you're mortgaging your future by accumulating high-interest, hard-to-repay credit card debt. A Demos survey entitled "The Plastic Safety Net: The Reality Behind Credit Card Debt in America" found that one of three American households reported using credit cards to cover basic living expenses four out of 12 months on average.

Half of those consumers using credit for living expenses missed or were late with a payment in the previous year; most credit card companies penalize cardholders by hiking the interest rate after just one late payment.

According to the Demos survey, for a household with the average amount of credit card debt ($8,650), an increase from 12 percent to a 25 percent default rate would translate to an additional $1,100 in costs, which then begins to compound and rapidly escalate your total debt.

Not Reading Loan Documents

By signing a loan document, you become legally responsible for repaying the loan according to its terms and conditions. If you don't carefully read and ensure that you understand those conditions, you may wind up agreeing to something that realistically you won't be able to afford to repay. That's exactly what happened for millions of subprime mortgage holders who took on adjustable-rate mortgages which "reset" to much higher interest rates that they could not afford.

According to the Center for Responsible Lending, 61 percent of all the home buyers who obtained these subprime loans in 2006 could have qualified for a "prime" loan with better terms. Those borrowers paid an extra $5,222 during the first four years of their loan for getting a subprime instead of prime loan and they defaulted at a rate three times higher than borrowers who obtained lower-rate, non-subprime loans.

Making the Minimum

According to Experian's 2007 national score index study, one in six families with credit cards pays only the minimum amount due each month. By paying the minimum you're going to pay much more in interest than if you paid only slightly more each month. For example, look at what would happen if you paid only the minimum amount due compared to paying a fixed amount (above the minimum) monthly on a $2,000 balance on a card charging 18.5 percent interest (see box).

Having Inadequate Insurance

While the U.S. Census Bureau currently reports that approximately 47 million Americans are without health insurance, the number of people who are underinsured skyrocketed by 60 percent between 2003 and 2007. In 2007, according to a survey by The Commonwealth Fund, 25 million adults under 65 were underinsured -- meaning that they have coverage but their policies require high out-of-pocket costs (not including their premium cost) relative to their income.

If you don't have adequate savings to cover those high costs, you could quickly become of the 1.5-plus million Americans who file bankruptcy annually. According to an August 2009 American Journal of Medicine article, the number of Americans filing for bankruptcies due to medical bills increased by nearly 50 percent between 2001 and 2007.

Too Many Eggs: One Basket

If Enron taught us anything, it's that you should never have the majority of your retirement plan savings invested in your own company's stock. While most financial advisers recommend having no more than approximately 10 percent of your total retirement investment assets in company stock, according to a 2008 Employee Benefits Research Institute study, 8 percent of employees have more than 80 percent of their 401(k) savings invested in company stock and almost 19 percent of employees age 60+ have more than half their 401(k) assets invested in their company's stock.

Being overly exposed to fluctuations in one company is a risky mistake to make. Just ask those Enron workers -- nearly 58 percent of workers' 401(k) assets were invested in the company's stock when its value plummeted by nearly 99 percent in 2001.

Missing the Date

Paying your bills by just a few days or weeks late makes a big difference. That's because timely bill payment is the No. 1 factor credit bureaus take into consideration when determining your credit score, the tool that lenders use when determining if they will make you a loan or extend credit, how much they'll lend to you and how much money they'll charge (the interest rate and fees) for doing so.

According to the National Foundation for Credit Counseling, 34 million Americans (15 percent of all adults in the U.S.) made a late credit card payment between April 2008-2009 and 18 million cardholders missed a payment entirely.

Using Your Heart, Not Your Head

Sure, your friend's startup sounds like an exciting venture, but if it fails, can you afford to lose the $10,000 you're thinking about investing in it? Or while you'd like to keep your home as part of the divorce agreement because you're emotionally attached to the property, can you really afford the mortgage, insurance, upkeep and taxes on your post-divorce income? Emotions are powerful forces but when left unchecked they can unduly influence you to make decisions that are not in your financial best interest.

Whether it's pulling out of the market because you're panicked about a drop in the Dow (and potentially losing out on long-term gains) or co-signing a loan because you feel badly for a family member who's down on his or her luck (and potentially being stuck with a loan you can't afford to repay if he or she defaults on it), do your financial due diligence and get an expert second opinion before you risk making a choice that's going to cost you in the long run.

The Bottom Line

Keep these warnings in mind when managing your money and you could avoid making costly mistakes. The information is out there, so don't be afraid to ask for advice and do your research before jumping in.