Becoming wealthy requires more than a high income. You also need to control where that money goes.Image source: Getty Images.
You can envision the vacations, fancy cars, and freedom that come with being fabulously wealthy. Now all you need is a way to get there. A good first step is to quit throwing your money away on costly items that offer you little to no benefit in return. Here are five money pits you should make sure you don't fall into.
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1. Expensive mutual funds
All mutual funds have expense ratios, which are annual fees that all shareholders must pay. The expense ratio is a percentage of your assets, and it's automatically deducted from your account, so you may not even realize you're paying it. If you have $1,000 invested in a mutual fund with a 1% expense ratio, that means you'll pay $10 every year to own the mutual fund, and as the value of our investment rises, so does your expense ratio. Over time these fees can add up and hamper the growth of your investments.
Actively managed mutual funds -- those run by a fund manager who is responsible for selecting the investments within the fund -- typically have relatively high expense ratios. They tend to buy and sell assets more frequently, and those transactions come at a cost. The funds' stockpickers also need to be paid. Those added costs get passed on to shareholders through the expense ratio. Actively managed mutual funds typically charge between 0.5% and 1% of your assets per year, and some charge even more than this.
Passively managed mutual funds, such as index funds, are typically more affordable because they have lower turnover, and there's less work for fund managers to do. Index funds simply imitate the asset allocation of a market index, such as the S&P 500. Because they're composed of the same investments as the index, they mirror its performance. These funds typically have expense ratios of around 0.2%.
By investing in funds that charge lower expense ratios, you reduce how much you pay out each year in fees and keep more of your profits. If you're unsure how much you're paying in fees, check the prospectus for your funds and consider moving your money to lower-cost options if you find you're paying more than 1% of your assets each year.
2. Credit card interest
Carrying a balance on your credit cards is never a good idea. You're essentially flushing your money down the toilet, and credit cards' high interest rates, which often exceed 20%, make it difficult to get out of debt once you get into it. Never charge more to your credit cards than you can pay back in full each month.
If you're already in debt, create a plan to get out of it. Figure out how much money you have left over after paying your bills each month and put the majority of this toward your debt repayment. When you get extra money, like a yearly bonus or a tax refund, put this toward your debt as well. Try to pay down one card at a time, but be sure to make the minimum payments on all of them to avoid late payment fees and penalty APRs.
3. More house than you need
A big house can make you look and feel wealthy, but it could actually keep you from growing your wealth over the long run. Larger homes are more expensive in every way, including their mortgage payments, property taxes, homeowners insurance, utilities, and maintenance. Meanwhile, you may not even use all of that space.
When buying a new home, be realistic about how much house you actually need. If you think you'll only use a guest bedroom or formal dining room once or twice a year, you're better off skipping it. Instead, purchase a smaller home with a lower mortgage payment and take the extra money you're saving each month and invest it or use it to pay down your mortgage more quickly.
4. Insurance with low deductibles
Insurance policies with low deductibles may seem appealing, because you'll have lower out-of-pocket costs in the event of a claim. But that also means you'll be stuck paying higher premiums, and chances are good that the extra premiums you pay will exceed the amount you may save through your lower deductible.
The smarter move is to go with a higher deductible on all of your insurance policies in exchange for lower premiums. If you don't already have one, start an emergency fund. Set aside a little money every month until you have at least enough to cover your insurance deductibles (and three to six months of living expenses is an even better target). This way you'll be able to cover your higher deductible, should you need to file a claim, without taking on new debt.
5. Lottery tickets
A lot of people understandably daydream about instantly winning millions, but the odds are never in your favor. You may not care that much about losing a few dollars, but if you play regularly, the losses begin to add up, and they could become serious if you have a gambling problem. Plus, even if you do win, it may not be the triumph you'd hoped for. You'll lose a lot of the winnings to taxes, and you'll have people asking you for money everywhere you turn.
Rather than spending money on lottery tickets, consider investing. While there is still some risk involved, the odds are far better, especially if you keep your money well-diversified. Just don't treat investing like gambling, and don't try to time the market by selling at what you think is a peak. You're better off buying and holding over the long term.
Building wealth isn't just about increasing the money you bring in. It's also about understanding and limiting where your money is going out. Avoiding these five hazards is a good place to start.