Your 40s should be the most financially empowering decade of your life. After all, both men and women reach their peak earning potential in their 40s, according to PayScale.com.
But the bigger your paychecks get, the more difficult it can be to keep your finances in control. Suddenly, the things you thought you could afford — the monthly mortgage payments, the occasional vacation, the SUV, your kids’ dance lessons — become too much to bear.
When that happens, keeping an eye on the present while still planning for your future is a challenge. Things like retirement and college savings accounts may go underfunded -- or unfunded -- while you struggle to stretch your bank account.
To help you make the most of this decade, here are a few common money mistakes to avoid:
Super-sizing your house.
By the time you’ve reached your 40s, you may feel as if you’ve outgrown the cozy starter home that felt perfectly spacious when you were in your 30s. Resist the temptation to buy more house than you can comfortably afford. Apart from taking on a bigger mortgage, larger homes mean more electricity costs, higher maintenance fees, and steeper property taxes, too.
“Maintaining the family home often means sacrificing on retirement and college savings and can be a big mistake,” says James Kinney, a certified financial planner in Bridgewater, N.J. “I have found that among my clients those best prepared for retirement are those with the most modest homes in comparison to their incomes."
Putting your kids’ college fund before your retirement savings.
College costs are out of control today, but parents who put off their own retirement savings to bankroll their kids’ education could be making an unnecessary sacrifice. You or your children can take out a low-cost loan to fund a college degree. But when retirement rolls around, trust us, lenders aren’t exactly going to rush to your aid.
It’s a mistake Cheryl Costa, a financial planner in Framingham, Mass., sees all too often among her 40-something clients. “If they have children, the No. 1 mistake is paying college tuition without knowing for sure that their own retirement is secure,” she says. “Before the parents and children even take their first college tour, parents must prepare retirement projections.”
If you are concerned about college costs (as you well should be — tuition has tripled over the last decade alone), there’s a lot you can do to trim those costs if you start while your kids are still in high school. Start with their performance in class. Good grades mean more potential for academic scholarships. Get them involved in after-school activities that will impress college admissions counselors. Look for private college scholarship opportunities at local businesses or through your employer. When it comes time to apply to schools, put state schools and community colleges at the top of your list.
Saving for retirement like a 20-something.
Having a false sense of wealth can lead you to underestimate your financial needs for the long haul. That 5% savings rate you used in your 20s won’t cut it forever. Once you reach your 40s, your income will likely peak and flatten out, while your largest expenses — housing, education, transportation, child care and health care — will only increase. Michele Clark, a certified financial planner in Chesterfield, Mo., advises her clients to increase their retirement contributions by at least 1% each year they are in the workforce.
“When they are in their mid-60s, [people] are surprised to find out that just contributing enough to the 401(k) so they get the company match was not enough to fund the lifestyle to which they have become accustomed,” she says. “But if they had increased their 401(k) contribution by 1% per year each year when their got their raise and did that for many years, they would be in much better shape.”
Investing too conservatively.
Depending on your tolerance for risk, some advisors caution workers from being too conservative with their investments as they reach their 40s. Arguably, you still have another 20 or so years ahead of you to reap potential gains from your investment choices.
“You have to remember you’re planning for life after 65,” says Samirian Hall, president of BudgetWise Financial, a financial advisory firm in Southfield, Mich. “It’s not always time to completely rein it in. You want a moderately aggressive portfolio and you don’t really want to become too moderate until your 50s.”
It might feel nice to take cover in low-risk CDs or bonds, but by putting all or most of your money in those safer investments during your peak earning years you could wind up with an insufficient nest egg.
It’s important to determine the asset allocation that’s right for you -- for a 40-something, that generally entails a good chunk of your portfolio invested in equities.
But as Hill notes, everyone should make their investment choices based on their own comfort level with risk, something a financial advisor can help you assess.
Using bankruptcy as a band-aid.
Following the latest recession, more than 1.4 million Americans fled to bankruptcy court in 2009, surging 32% from the year before, according to the National Bankruptcy Research Center. At the time, housing values were plummeting, millions of jobs were disappearing, and people increasingly leaned on debt to scrape by. But bankruptcy is only a temporary solution, Hill says.
“People want to file [for] bankruptcy because they want a quick fix as opposed taking the long methodical approach to debt,” she says. “You have to address the behaviors and habits that go with debt. I’ve seen people file bankruptcy one year and they’re filing it again in another two years because to them it’s become the answer.”
There are longer-term consequences to consider before filing bankruptcy. The damage it does to your credit score will linger for seven years. Potential employers could be dissuaded from hiring you, especially if you’re looking for work in the financial sector. And any new lines of credit you open will almost surely come with sky-high interest rates.
Leaving your end-of-life care up to chance.
Once you are married, buy a home or become a parent, there’s no longer any valid reason to avoid the inevitable — your death. If you’ve been blissfully ignoring this fact, you’re not nearly alone: about half of Americans don’t have a will.
In addition to making sure you have a sufficient life insurance policy, you should meet with an attorney to hammer out a complete estate plan. This is a list of documents that includes your will, an advance medical directive, a living will and also designates a financial power of attorney. A will will keep your kids from squabbling over who gets dibs on your antiques collection and a power of attorney will ensure that someone you trust can make financial and legal decisions on your behalf if you become incapacitated. At the very least, draw up a living will, which will dictate how you want your end of life care to be handled if you’re too ill to communicate your wishes.
Treating your 401(k) — and your mortgage — like a piggy bank.
Before you dip into your 401(k) or take out a home equity loan, just imagine yourself hopping in a time machine, catapulting into the future, and robbing your 80-year-old self blind. Sadly, far too many Americans tend to treat their nest egg like an emergency fund when they fall on hard times, or like a bonus check when they switch jobs. More than 30% of people in their 40s cashed out their 401(k) accounts and after changing jobs in 2013, according to a study by Bloomberg. Not only do you face steep tax penalties for early withdrawals, but you miss out on years of potential gains and compound interest as well.
Using your home equity as a piggy bank is just as dangerous. You will be hit with fees for refinancing, face additional interest payments and, worst of all, you could wind up paying more for your home than it’s actually worth, says Ajay Kaisth, a certified financial planner in Princeton, N.J.
“[Cash-out refinancing] may be the right thing to do under certain circumstances, but these need to be evaluated carefully,” Kaisth says. “For example, using home equity for temporary emergency expenses (via a HELOC), or for educational expenses, may be justified. But using home-equity to finance an expensive car, or an expensive vacation is likely not to be a good financial move.”
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