In October 2022, the Federal Reserve gathered a study to analyze the financial well-being of households. Results from the Survey of Household Economics and Decision-making report showed that the overall financial well-being of adults who were worse off financially from one year ago rose to 35%, the highest level in nearly a decade.1 Whether by poor financial decisions or harsh macroeconomic conditions, it remains extremely important to remain financially diligent and make smart choices with your money.

Here we’ll take a look at some of the most common financial mistakes that often lead people to major economic hardship. Even if you’re already facing financial difficulties, steering clear of these mistakes could be the key to survival.

KEY TAKEAWAYS

• Financial diligence is crucial, and avoiding common mistakes during economic challenges is key to survival regardless of your currently financial health.
• Small, regular expenses accumulate, impacting financial stability, especially during hardships.
• Relying on credit cards for essentials or financing depreciating assets can worsen financial woes.
• Overspending on housing leads to higher taxes and maintenance, straining monthly budgets.

1. Excessive and Frivolous Spending

Great fortunes are often lost one dollar at a time. It may not seem like a big deal when you pick up that double-mocha cappuccino or have dinner out or order that pay-per-view movie, but every little item adds up.

Just $25 per week spent on dining out costs you $1,300 per year, which could go toward an extra credit card or auto payment or several extra payments. If you’re enduring financial hardship, avoiding this mistake really matters—after all, if you’re only a few dollars away from foreclosure or bankruptcy, every dollar will count more than ever.

2. Never-Ending Payments

Ask yourself if you really need items that keep you paying every month, year after year. Things like cable television, music services, or high-end gym memberships can force you to pay unceasingly but leave you owning nothing. When money is tight, or you just want to save more, creating a leaner lifestyle can go a long way to fattening your savings and cushioning yourself from financial hardship.

3. Living on Borrowed Money

Using credit cards to buy essentials has become somewhat commonplace. Even if an ever-increasing number of consumers are willing to pay double-digit interest rates on gasoline, groceries, and a host of other items that are gone long before the bill is paid in full, it’s not wise financial advice to do so. Credit card interest rates make the price of the charged items a great deal more expensive. In some cases, using credit can also mean you’ll spend more than you earn.

According to research by Investopedia, the median rate of interest across all credit cards in the Investopedia database for December 2023 was 24.37%.2

4. Buying a New Car

Millions of new cars are sold each year, although few buyers can afford to pay for them in cash. However, the inability to pay cash for a new car can also mean an inability to afford the car. After all, being able to afford the payment is not the same as being able to afford the car.

Furthermore, by borrowing money to buy a car, the consumer pays interest on a depreciating asset, which amplifies the difference between the value of the car and the price paid for it. Worse yet, many people trade in their cars every two or three years and lose money on every trade.

Sometimes a person has no choice but to take out a loan to buy a car, but how many consumers really need a large SUV? Such vehicles are expensive to buy, insure, and fuel. Unless you tow a boat or trailer or need an SUV to earn a living, it can be disadvantageous to purchase one.

If you need to buy a car and/or borrow money to do so, consider buying one that uses less gas and costs less to insure and maintain. Cars are expensive, and if you’re buying more of a car than you need, you might be burning through money that could have been saved or used to pay off debt.

5. Spending Too Much on Your House

When it comes to buying a house, bigger is not necessarily better. Unless you have a large family, choosing a 6,000-square-foot home will only mean more expensive taxes, maintenance, and utilities. Before you buy a home, consider the carrying and operating costs beyond your monthly mortgage payment. Do you really want to put such a significant, long-term dent in your monthly budget?

As you consider your housing arrangement, think through what’s important to you. For example, how passionate are you about having a large yard? If it’s at the top of your list, that’s fine – just be mindful that upkeep and maintenance may cost you in the form of hiring services, buying machinery, complying with HOA requirements, and mitigating unforeseen problems that arise.

6. Using Home Equity Like a Piggy Bank

Refinancing and taking cash out of your home means giving away ownership to someone else. In some cases, refinancing might make sense If you can lower your rate or if you can refinance and pay off higher-interest debt.

However, the other alternative is to open a home equity line of credit (HELOC). This allows you to effectively use the equity in your home like a credit card. This could mean paying unnecessary interest for the sake of using your home equity line of credit.3

7. Living Paycheck to Paycheck

In June 2021, the U.S. household personal savings rate was 9.4%. A little over two years later, the personal savings rate had dropped to just 3.8% in October 2023.4 Many households may live paycheck to paycheck, and this continues to be a trend that appears to be worsening when strictly looking just at how much people save each paycheck.

The cumulative result of overspending puts people into a precarious position—one in which they need every dime they earn and one missed paycheck would be disastrous. This is not the position you want to find yourself in when an economic recession hits. If this happens, you’ll have very few options. 

Many financial planners will tell you to keep three months’ worth of expenses in an account where you can access it quickly. Loss of employment or changes in the economy could drain your savings and place you in a cycle of debt paying for debt. A three-month buffer could be the difference between keeping or losing your house. 

Household savings did spike during the pandemic.4 However, be mindful that one-time savings do depreciate and any nest egg that was accumulated during the pandemic may have since been spent down.

8. Not Investing in Retirement

If you do not get your money working for you in the markets or through other income-producing investments, you may never be able to stop working. Making monthly contributions to designated retirement accounts is essential for a comfortable retirement.

Take advantage of tax-deferred retirement accounts and/or your employer-sponsored plan. Understand the time your investments will have to grow and how much risk you can tolerate. Consult a qualified financial advisor to match this with your goals if possible. 

9. Paying Off Debt With Savings

You may be thinking that if your debt is costing 19% and your retirement account is making 7%, swapping the retirement for the debt means you will be pocketing the difference. But it’s not that simple.

In addition to losing the power of compounding, it’s very hard to pay back those retirement funds, and you could be hit with hefty fees. With the right mindset, borrowing from your retirement account can be a viable option, but even the most disciplined planners have a tough time placing money aside to rebuild these accounts.

When the debt gets paid off, the urgency to pay it back usually goes away. It will be very tempting to continue spending at the same pace, which means you could go back into debt again. If you are going to pay off debt with savings, you have to live like you still have a debt to pay—to your retirement fund. 

10. Not Having a Plan

Your financial future depends on what is going on right now. People spend countless hours watching TV or scrolling through their social media feeds, but setting aside two hours a week for their finances is out of the question. You need to know where you are going. Make spending some time planning your finances a priority.

Why Should Individuals Avoid Living on Borrowed Money?

Living on borrowed money, such as relying on credit cards for essentials, can worsen financial difficulties. While it may provide a short-term solution, the long-term consequences, such as high-interest payments and accumulating debt, can lead to a cycle of financial stress. This financial stress can snowball, causing you higher expenses in the future that continue to make it harder and harder to catch-up to.

How Does Overspending on a House Affect Monthly Budgets?

Overspending on a house can strain monthly budgets due to higher taxes, maintenance costs, repairs and maintenance, and utilities. It may also be easier to live a more lavish lifestyle with a larger house; with more storage space or rooms to fill, there’s a psychological aspect to spending.

In What Ways Can Using Home Equity Like a Piggy Bank be Detrimental?

Using home equity like a piggy bank, whether through refinancing or a home equity line of credit (HELOC), can have detrimental consequences. While it may provide access to cash, it comes at the cost of increased debt and interest payments.

Why Is Having a Well-Defined Financial Plan Important?

Having a well-defined financial plan is essential for securing a stable and prosperous financial future. A comprehensive plan helps individuals set clear goals, encourage you to allocate money wisely, and navigate economic uncertainties. Your financial plan serves as a roadmap for making informed financial decisions, including budgeting, saving, investing, and preparing for future milestones such as homeownership, education, and retirement.

The Bottom Line

To steer yourself away from the dangers of overspending, start by monitoring the little expenses that add up quickly, then move on to monitoring the big expenses. Think carefully before adding new debts to your list of payments, and keep in mind that being able to make a payment isn’t the same as being able to afford the purchase. Finally, make saving some of what you earn a monthly priority, along with spending time developing a sound financial plan.