It’s that time of year when people begin thinking about how they’ll improve their lives in the new year. For many that includes looking for ways to make a fresh start with their money. Nearly…
It’s that time of year when people begin thinking about how they’ll improve their lives in the new year. For many that includes looking for ways to make a fresh start with their money. Nearly a third of adults are planning to make a financial resolution for 2019, according to a survey of 2,005 adults for the Fidelity Investments 10th annual New Year Financial Resolutions Study.
While taking steps to improve your financial situation is laudable, be careful not to fall into common traps that can sabotage your success. “Don’t be too ambitious about your goals,” says Maura Cassidy, vice president of retirement and small business for Fidelity. That means not stretching for goals you’re unlikely to reach. “Don’t try to save $1 million by next year,” Cassidy says as one exaggerated example.
Instead, develop resolutions that are not only attainable but also pertain to your specific situation. “You have to sit down and figure out your financial goals for the year,” says Kevin Brauer, chief financial officer for Affinity Federal Credit Union. Once you know those, you can identify specific steps, such as increasing savings, reducing spending or making lifestyle changes such as moving or finding a new job.
It’s best to create resolutions that are both specific and measurable so you know when you’ve achieved your goal. However, be aware that some common resolutions can actually make it more difficult to be financially successful. For example, the five resolutions below are ones you shouldn’t make, let alone keep.
Resolution No. 1: I Will Focus All My Extra Money on Paying Down Debt
Why you shouldn’t keep it: Nearly 3 in 10 survey respondents told Fidelity they were likely to make paying down debt their New Year’s resolution. That’s not a bad resolution, but you want to be smart about it.
“If you make it so that you eliminate all the fun out of life, you’re most likely to fail on your financial resolutions overall,” Brauer says. Rather than earmarking every last cent for debt, budget some money for discretionary purchases. How much to spend on these expenses can vary depending on your income, but generally, it’s a good rule of thumb to budget no more than 10 percent of your take-home pay for this purpose. By spending a small amount on the things you want, you’re more likely to stick to your financial plan in the long run.
A second risk with this resolution is neglecting other financial priorities. “Focus on paying off debt, but not to the detriment of savings,” says Joe Wirbick, author of “Everything They Never Told You About Retirement” and president of advisory firm Sequinox in Lancaster, Pennsylvania. Without emergency savings, it could be harder to get out of debt, and you don’t want to wait years to start putting money aside for retirement.
Resolution No. 2: I Will Consolidate My Debt Using Whatever Means Possible
Why you shouldn’t keep it: Consolidating debt can be helpful, particularly if you have high-interest credit cards that can be rolled into a lower-interest loan. However, not all consolidation methods are created equal. For instance, it might be tempting to take out a 401(k) loan to pay off debt, but these loans can negatively impact retirement savings and may be subject to taxes and penalties if not paid off prior to leaving your employment. Plus, five years is the maximum term allowed for most 401(k) loans. Consider taking out a personal loan from a bank or credit union instead.
What’s more, rising interest rates make some previously attractive consolidation options less appealing. “Now is a terrible time to refinance,” Wirbick says. Given increased interest rates and closing costs that can run into the thousands, he doesn’t recommend consolidating debt using this method.
A home equity line of credit may be a better option, but don’t think you can deduct the interest from your federal income taxes. Under the Tax Cuts and Jobs Act, interest on home equity loans or lines of credit taken out for debt consolidation cannot be deducted.
Resolution No. 3: I Will Work Through a List of Goals
Why you shouldn’t keep it: It can be natural to want to check items off a list, but this approach can backfire. “Don’t make one financial goal that gets in the way of your other goals,” Cassidy says.
Instead of planning to run down a list of financial goals in order, create resolutions that you will pursue independently and simultaneously. Not only will that position you to achieve multiple goals at once, but it also prevents you from getting bogged down in one aspect of your financial life, such as paying off debt, while ignoring other priorities like saving for retirement or college.
Resolution No. 4: I Will Contribute More to a Traditional 401(k) or IRA
Why you shouldn’t keep it: It can be hard to imagine there is anything wrong with contributing more to your 401(k) or IRA next year, but putting money into a traditional retirement account isn’t ideal. A better resolution is to contribute money to a Roth accounts.
While traditional 401(k) and IRA accounts provide taxpayers with an immediate deduction for contributions, Roth 401(k) and IRA accounts are funded with after-tax dollars. Then, the money grows tax-free and can be withdrawn tax-free in retirement. Meanwhile, money in traditional accounts will be subject to income tax in retirement. With lower tax brackets in effect for at least the next five years as a result of the Tax Cuts and Jobs Act, it may make financial sense for most workers to pay taxes on contributions now and avoid the taxman later.
Plus, Roth IRAs have an added perk. “If you needed to tap into it for some emergency or to buy a house, you can,” Cassidy says. Since contributions to a Roth IRA are already taxed, people can withdraw the principal at any time without penalty. Since withdrawals from Roth 401(k) accounts are prorated between contributions and earnings, a penalty-free early withdrawal isn’t usually possible with these accounts.
Resolution No. 5: I Will Shop for Cheap Car Insurance
Why you shouldn’t keep it: Fifteen percent of people say they think they’ll resolve to spend less in the next 12 months, according to the Fidelity study. If this is your New Year’s resolution, shopping for new car insurance could be on your list of ways to cut costs.
However, Wirbick cautions against reducing costs by dropping coverage. Eliminating comprehensive coverage can save a significant amount in premiums, but it could leave you worse off financially in the long-run. “You have one accident, and it could wipe out your savings,” Wirbick says.
A better approach is to determine your coverage needs, and then look for a highly rated company that provides that level of protection at a reasonable rate, or check with your current insurer and see if you might be eligible for discounts that don’t involve raising your deductible or lowering your coverage. In the end, you don’t necessarily want the cheapest car insurance, but rather the policy that offers the best value.