Mark Hauser, Managing Partner at Hauser Private Equity and experienced financial expert, highlights three common financial mistakes and offers potential strategic resolutions.

Developing good financial habits generally doesn’t happen on its own. Building an effective money management toolkit often begins with education from parents or other adults. Substantial reading and research, and perhaps guidance from a qualified financial professional, can provide the foundation for a lifetime of good financial decisions.

Equally importantly, a good financial education should include guidance on what NOT to do. Toward this end, private equity principal Mark Hauser discusses three financial mistakes no one should allow themselves to make. He also offers recommendations to help resolve each issue and choose a different path in the future.

Neglecting to Sufficiently Fund a Retirement Plan

A well-structured (and well-funded) retirement plan can position an individual for a comfortable lifestyle in their golden years. Whether they want to travel, pursue a favourite hobby, or spend time with family and friends, they’ll ideally have sufficient financial resources on hand.

Private equity principal Mark Hauser emphasizes the importance of prioritizing retirement savings contributions. Some individuals authorize automatic payroll deposits into an employer’s 401(k) plan. Others maintain their own Individual Retirement Account (or IRA), making contributions on a predetermined schedule. Traditional and Roth IRAs each offer distinctive advantages.

Either strategy can help produce the desired results ─ with one important caveat. The individual must maintain their commitment to consistently grow their retirement account balance. Instead of spending the funds on a vacation, or splurging on something they want, the retirement account contribution should come first.

For perspective, financial experts recommend that workers regularly send 15 per cent of their income to a retirement account. If that’s not currently feasible, Mark Hauser advises that they begin with a budget-friendly number. Each year, the worker should increase it by one or two percentage points.

Two Benefits of Regular Retirement Savings

Consistent retirement savers reap two important financial benefits. First, these individuals will ideally begin saving for retirement shortly after they enter the workforce. As each person adds funds to their retirement account, compound interest will apply to an ever-larger balance.  

In addition, a regularly funded retirement account offers some protection against market volatility. Retirement plan contributions typically go into a 401(k) or IRA account, with the proceeds invested in the stock market.

By investing early and consistently, individuals will be better positioned to handle short-term stock market downturns. Younger investors may also be able to aggressively invest for potentially higher yields.

Effects of Retirement Account Disruptions

When individuals delay establishing their retirement account, they’ll accumulate less money even with compound interest. Workers who practice a “start and stop” funding strategy will likewise see reduced financial benefits. Perhaps most importantly, private equity expert Mark Hauser emphasizes that prematurely removing money from a retirement account can result in stiff financial penalties.

For perspective, the Internal Revenue Service (or IRS) notes that if an individual withdraws IRA funds before age 59½, that money will be treated as part of their gross income. In addition, they’ll receive a 10 per cent tax penalty for the withdrawal.

Limited exceptions apply, such as using IRA investments to cover a medical insurance premium following a job loss. However, few scenarios will qualify for an early retirement account withdrawal exemption.

Increasing Retirement Plan Contributions is Key

Once these retirement funds are depleted, cash-strapped individuals will find it difficult to fully replenish their account balances. To minimize the damage, private equity principal Mark Hauser recommends that workers increase their retirement account contributions to the maximum allowable amount.

Raiding a Targeted Emergency Fund

An adequate emergency fund can help prevent an unexpected event from becoming a financial disaster. In case of an accident, malfunctioning appliance, or car repair (among other events), an emergency fund can help pay for often-costly expenses. The individual or family can minimize (or perhaps avoid) resorting to credit card debt or savings account liquidation.

Private equity expert Mark Hauser emphasizes that an emergency fund should only be used for financial emergencies. The fund shouldn’t be used for groceries, everyday essentials, or shopping splurges. Likewise, the emergency fund shouldn’t function as a targeted savings plan or vacation account. Essentially, an emergency fund functions only as a much-needed safety net.

An emergency fund’s parameters will depend on the individual’s (or family’s) income, expenses, and number of dependents. A frugal family’s emergency fund will differ from one based on a higher-end lifestyle. Either way, Mark Hauser recommends that the fund include three to six months’ customary living expenses. Factors to be considered include an individual’s job stability and upcoming large expenses.

The emergency savings should be held in an easily accessible, interest-bearing account. A savings or money market account will both work. Equally importantly, the individual can withdraw the cash without worrying about penalties or taxes due. Private equity principal Mark Hauser warns against holding emergency fund dollars in vehicles that can fluctuate in value. Examples include stocks and mutual funds.  

Effects of Improper Emergency Fund Use

In an emergency, using the emergency fund dollars is entirely appropriate. However, multiple unrelated withdrawals could soon deplete the fund, possibly leaving little or no cash for an actual emergency. Then, the individual or family could conclude that credit card or loan funds would be their only recourse. Mark Hauser stresses that neither option is the right choice.

Strategies for Rebuilding the Emergency Fund

After an individual or family makes an emergency fund withdrawal, they should quickly begin to rebuild the account. Three strategies will help accomplish this goal.

• Define a Monthly Deposit Target: The individual or family should establish a monthly savings target. This manageable amount should be integrated into the monthly budget. Automatic deposits will remove the temptation to use the money for another purpose.
• Generate Additional Household Income: Bringing in more income, and targeting that money to the emergency fund, is a workable strategy. Adding a part-time job, or selling unnecessary possessions, are good tactics. Naturally, the individual or family should consider the tax implications of adding another income source.
• Allocate Lump Sums to the Emergency Fund: An employment bonus, tax refund, or inheritance would be a welcome boost to the emergency fund. Although it’s tempting to use the money for something fun, an extra fund deposit would put the individual or family in a better financial position.

Racking Up Excessive “Bad Debt” Obligations

The concept of debt may automatically conjure up visions of piled-up, unpaid bills, and high credit card balances. It’s true that “bad debt” can cause an individual to become financially overwhelmed. This unfortunate situation can often negatively impact other aspects of their lives.

In contrast, “good debt” can play a positive role in an individual’s current and future financial health. Private equity expert Mark Hauser highlights the difference between the three forms of debt.

“Good Debt” Defined

“Good debt” refers to debt with a low, fixed interest rate. In addition, the loan is designed to purchase an item that appreciates. To illustrate, a 3 per cent mortgage on a personal residence is “good debt.” The borrower can also deduct the mortgage interest from their taxes.

A low-interest loan for a growing small business would also qualify as “good debt.” Here, the loan interest is deductible from the business’ tax liability. However, the business owner cannot deduct the loan principal from their taxes.

“Bad Debt” Defined

“Bad debt” finances a purchase that won’t enhance an individual’s net worth or income potential. The purchased item may also depreciate over time. This debt typically carries a high-interest rate or a variable interest rate that could potentially increase. For perspective, this means the buyer will pay an often-exorbitant amount of money for an item that’s often worth less than its purchase price.

Credit card debt is “bad debt” personified. Many consumers prefer to pull out their credit cards rather than hand over cash for a purchase. Although perhaps less painful at the time, running up high-interest credit card debt can often set the stage for financial disaster.

To illustrate, some credit card annual percentage rates (or APRs) are over 20 per cent. With these cards often used to buy consumables, the purchaser has little to show for their financial indiscretion.

“Toxic Debt” Defined

However, Mark Hauser stresses that “toxic debt” is even worse. These payday loans and no-credit-check loans carry APRs that typically exceed 36 per cent. Over time, the borrower pays more than the item is worth. Loans requiring valuable collateral, such as an individual’s car, are another type of toxic debt.

Strategies for Eliminating “Bad Debt” or “Toxic Debt”

This “bad debt” will never magically disappear. However, private equity expert Mark Hauser recommends that borrowers adopt one of three strategies designed to get the debt under control. With this as a foundation, individuals can take steps to make more constructive financial decisions.

Adopt a Debt Reduction Plan

In some situations, reducing “bad debt” could be the best choice. Here, borrowers list their debts and their respective balances, interest rates, and minimum payments. Equipped with this information, individuals design a budget-friendly debt repayment plan. They often begin by focusing on credit cards, a common type of high-interest debt.

With the “snowball method,” the borrower applies extra funds to the smallest credit card balance. They make the minimum payments on other existing debts. When the smallest card is zeroed out, the borrower repeats the strategy with the next smallest balance. Alternatively, the borrower may first target the balances with the heftiest interest rates.

Implement a Debt Consolidation Plan

Borrowers with credit card debt (and other steep-interest revolving debt) may consider a debt consolidation loan. Here, the borrower obtains a new loan offering a lower interest rate and often a lower monthly payment. The borrower applies these funds to pay off their high-interest balances. Taking a similar tack, the borrower may consider refinancing term-based loans such as mortgages, student loans, and car loans.

Partner with a Credit Counselor

Some borrowers may feel so overwhelmed by debt they feel powerless to do anything. To move forward, private equity principal Mark Hauser suggests they consider a credit counselling agency.

A reputable, accredited credit counsellor will help their clients develop a plan for financial recovery. They should also offer financial education as part of their services. The National Foundation for Credit Counseling and the Financial Counseling Association of America have resources available.

Consumers Should Exercise Their Due Diligence

As with other financial services providers, due diligence is key to finding the right credit counsellor or agency for an individual’s needs. The federal Consumer Financial Protection Bureau offers tips on selecting this certified financial professional.

Finally, the agency explains how a credit counselling agency differs from a debt management (or debt relief) company. The two latter entities are for-profit businesses that often have a checkered consumer services track record. Private equity expert Mark Hauser strongly recommends that consumers thoroughly investigate these companies before deciding whether to partner with them.