Biggest money mistakes wealthy people make

Five Things Rich People Know That You Don’t
.

View photo

Financially successful people don’t build their wealth by accident, but through discipline and willpower. MarketWatch's Jim Jelter discusses five habits of the rich that you can start putting into practice now. (Photo: Getty Images)

The rich and famous may have a knack for earning millions of dollars, but that doesn’t always translate to holding onto that money, or investing it wisely.

For every financially savvy celebrity coupon clipper, like Kristen Bell, there’s a Nicolas Cage (had to pay the IRS $6 million in back taxes in 2012) or Toni Braxton (filed for bankruptcy twice) or Teri Polo of “Meet the Parents” fame (filed for bankruptcy this year): celebrities and other rich folks who, through overspending, overconfidence and general short-sightedness, manage to bungle their finances and squander their wealth.

For the rest of us, some of the best financial lessons can be learned from watching the fortunate foul up.

After all, it isn’t as if money flows into our bank accounts with an instruction manual on how to make it last. Whether they’ve earned their millions over the course of a lifetime or walked out of a 7-Eleven with a winning lottery ticket, the rich can fall into just as many bad money management traps as us mortals.

“There’s a pervasive attitude [among high earners] that financial planning doesn’t apply to them because they either make so much or have so much,” says Dan McElwee, a certified financial planner with Ventura Wealth Management in Ewing, N.J. “But in reality, their financial concerns are pretty universal.”

Here’s where the wealthy slip up — and what we can learn from their mistakes:

They mistake career success for financial know-how.

Career and financial success can lead people to think a little too highly of their financial prowess.

“They’re telling people what to do all day and they think that translates over into the investing world,” says Peter Mallouk, an independent financial advisor from Kansas City, Kan., and author of “The 5 Mistakes Every Investor Makes and How to Avoid Them.”

A behavioral finance expert might call this evidence of overconfidence, the type of mindset that can lead investors to ignore financial guidance because they think they’ve got the magic touch and are smarter than everyone else.

In “On Financial Frauds and Their Causes: Investor Overconfidence,” a study by Monmouth University economist Steven Pressman, researchers found victims of financial fraud were often led astray by their own egos. They also attributed overconfidence to the reason why men tend to perform worse than women in long-term investing.

"Because women are less likely to indulge in excessive trading, they outperform men," Pressman writes. "Investors who use traditional brokers, remaining in touch with them by telephone, achieve better results than online traders, who damage their performance by trading more actively and speculatively."

They lose perception of what income is.

Most often this affects people who unexpectedly come into money — whether it’s an inheritance from a generous relative’s estate or a surprise bonus at work. Things like estate taxes, income tax and long-term earning potential haven’t crossed their minds. As far as they’re concerned, they’re rich.

The hardest part of managing newfound wealth is helping people figure out exactly how much it really is, McElwee says. His advice is to sit down with a planner who can crunch the numbers and figure how to make the funds last long-term. Whether that means plunking your cash into an IRA, setting up trusts for family members or diversifying your assets in other ways, they can at the very least help ground your decisions in reality.

They retire and spend like there’s no tomorrow.

A million bucks isn’t what it used to be, but it can be hard to tell that to a wealthy retiree who’s determined to take advantage of a carefully-built nest egg.

“We see a lot of high-income earners who retire and are quick to go buy a big beach house, a condo in the city — the kinds of assets that can’t be turned into cash,” McElwee says. “They can become more of a burden than anything else.”

They don’t know when to quit.

High earners aren’t all trust fund babies. The vast majority have spent much of their years working to earn what they’ve got. Because of this, they tend to fear retirement in a way that many others may not.

Nick Ventura, founder of Ventura Wealth Management, says he once had to reassure a client — an executive earning seven figures who had $5 million saved for retirement — that she was adequately prepared to leave the workforce.

“People who are making a ton of money haven’t mentally prepared [for retirement],” Ventura says. “They’ve worked so hard for so long, the idea that they’re going to take their life’s work and [quit] is a very high-stress situation.”

One of the exercises he gives his clients to complete before retirement is to practice saying out loud what they plan to do in the first three, six and 12 months after they stop working.

“These are thoughts a highly compensated person isn’t think about,” he says. “They’re not thinking about ‘what am I going to do when this ends?’”

They’re too afraid of what they might lose.

Behavioral finance experts have long explored the link between loss aversion — a fear of losing despite what we might gain by taking a risk — and investing.

In the same way that high earners can be overconfident in their financial skills, they can also let their own fears drive them away from potentially lucrative investing choices.

“It can really cause paralysis,” Mallouk says. “If the stock market goes down, people go to bonds. If it goes up, they get back in. People think they’re protecting their wealth, but they really get in the way of themselves.”

In the years since the 2008 recession, for example, investors have recouped their losses, with average 401(k) balances nearly double what they were at the market lows of 2009. And the investors who fled the market during the financial crisis have missed out on the last few years of growth.

They can’t imagine being unhealthy or old.

If you ask a millionaire whether he or she has disability insurance through their employer, chances are they wouldn’t know the answer, says McElwee. Ditto long-term care insurance.

“It’s incredibly important to understand how your income would be replaced if you were to become disabled before retirement,” he says. “If you earn $500,000 and now all of a sudden you’re supposed to live off of [a disability check], we have a problem.”

Long-term care insurance is another often neglected safety net among wealthy workers. Without LTCI, the typical nursing home stay can cost tens of thousands of dollars per year.

“Right now we’re watching sizable estates with millions of dollars completely disappear as the owner is sitting in a nursing home paying $10,000 to $15,000 a month for their care,” Ventura says.

They pick the wrong kind of advisor.

Investment advisor fees can wreck anyone’s portfolio, and wealthy workers often wind up putting their money into very expensive hands. In a paper by Portfolio Solutions and Betterment, "The Case For Index Fund Portfolios," researchers looked at investment portfolios from 1997 to 2012. They found passively managed index fund portfolios outperformed comparable actively managed portfolios more than 80% of the time.

A big factor contributing to that difference is advisor fees, which often eat away at high returns achieved with actively managed funds.

“You need an independent advisor who’s a fiduciary,” someone acting in your best interests, Mallouk says. “Or else all you’re doing is paying somebody else to make the same mistakes you could make on your behalf, who, 90% of the time, has a conflict of interest.” 

Yahoo Finance is answering your money questions on Tumblr! Got a question about your credit score, your student loans, your retirement portfolio, your health insurance, or anything else finance-related? Drop us a line: YFmoneymailbag@yahoo.com.

More from Mandi:

Are college aid planners worth the money?

One-third of Americans are delinquent on their debt

The reign of payday lenders may soon be over

Related Video:

View Comments (209)