Wise men profit by the mistakes of others, while fools will not learn even from their own blunders. –Benjamin Franklin
We all face dozens of choices, large and small, every day of our lives. Should I hit the snooze button or go to the gym? What should I eat? Should I buy that? What should I watch? Should I keep working or call it a day?
Our choices add up over the years to bring us to the position we’re in today, regardless of whether we are happy with the outcome or not.
After a decade or more of adulthood, we can all look back and identify things we wished we would have done differently in our relationships, our careers, and our finances. Some of the lessons provided by this retrospection can keep us from making the same mistake again today. Other lessons will be too late for us individually, but there are people in our lives who are going through those same circumstances today who could benefit from our story.
I recently asked myself, what have I done with my money earlier in life that I would do differently in hindsight? My answers ranged from lesser-known “secrets” that were around years before I discovered them to bad investments to places where I put money when it had a better use. I would like to share a few of them with you today in hopes that you will find something of value that will save you thousands by taking action or by deliberately not taking the same action today.
1. Not Choosing a Health Savings Account (HSA) and Investing the Contributions
At the beginning of my career, I enrolled in the top tier health plan that my employer offered, which came with a lower deductible and a Flexible Savings Account (FSA). That seems like a wise decision, right?
The problem with an FSA is that you either use it or lose it each year. My wife and I were young and healthy, so we didn’t end up with any real medical expenses until our child was born 8 years later. In other words, we didn’t get much of the benefit that we were paying for.
It took me 5 years to come to the realization that the high-deductible health plan was the better option. It had lower costs up front and my employer began subsidizing it by contributing to the HSA alongside us.
Not only did this option save me money each year in total healthcare premiums, but it effectively gave me access to the best retirement account available. HSAs have the best possible tax advantages—better than an IRA, 401k, 403b, or 457! When invested in the stock market and spent on qualified medical expenses, all HSA dollars are exempt from:
- State income tax
- Federal income tax
- Federal payroll tax (Social Security and Medicare)
- Capital gains tax
Traditional retirement accounts such as IRAs and 401ks are considered tax deferred. State and federal income tax is due when withdrawals are made and payroll tax is still paid up front.
Roth IRAs and 401ks are exempt from capital gains tax, but state, federal, and payroll taxes are paid up front.
Table 1 compares several common tax advantaged accounts. An example is given to demonstrate the taxes that can be saved by an HSA relative to other accounts. Note that if you are self-employed, you pay an additional 7.65% employer payroll tax for all except the HSA!
*Assuming 22% federal, 4% state, 7.65% employee payroll, and 15% capital gains tax brackets
Between my wife’s HSA and mine, after about 10 years of using them, we now have more than $100k that we will never pay any taxes on! It took me a few of those years to convince my wife to use hers as a retirement account. Otherwise we would have even more there.
Many of you are now thinking, “That’s great, but what if I don’t have enough medical expenses in retirement to spend it all?” That won’t be a problem.
There is currently no statute of limitations on when you can be reimbursed by your HSA, so just hang on to all of the qualifying medical receipts that you have paid out of pocket—or better yet, scan and store them digitally—and redeem them at any point when you need the money!
Also keep in mind (as I have mentioned before) that Fidelity has estimated, “an average retired couple age 65 in 2022 may need approximately $315,000 saved (after tax) to cover health care expenses in retirement.”2 An HSA can even be used for band-aids, sunscreen, over-the-counter medicine, and massages.3 There will be plenty of opportunities to use HSA dollars.
This is a big deal! I encourage everyone with access to an HSA and the ability to pay for medical costs out of pocket to save the maximum in their HSA every year and invest it long-term.
A bonus for paying out of pocket is that you might shop around your medical care and even ask the provider how much a procedure or medication costs before consuming it. This is what employers are counting on and why high deductible plans are being subsidized today. They are saving both the employer/insurer and you money by making you a more conscious consumer of healthcare.
2. Not Contributing to a Mega Backdoor Roth
It took me at least 10 years to figure out that my employer’s retirement plan had all of the features necessary to perform what is unofficially called a mega backdoor Roth conversion. In fact, it probably took 7 years before I was even saving enough to take advantage of it.
A mega backdoor Roth IRA conversion can be made from 401k, 403b, and 457 plans that offer after tax contributions and in-service withdrawals. You will need to call your retirement plan administrator to find out if these features are available to you.
The strategy is to first max out your before tax contributions, then continue funding your after tax contributions up to the (higher) limit. You can then make annual conversions from your after-tax retirement account to a Roth IRA. At the point that they hit the IRA, they will no longer be taxed for capital gains. This gives the mega backdoor an advantage over taxable brokerage accounts that you might otherwise use once you have already maxed out all of your tax-advantaged accounts such as those mentioned in Table 1.
This strategy has greatly boosted my Roth IRA balance over the past several years. Instead of contributing just $5-6k to a Roth, I was able to put in around $30k per year!
Legislation has recently been proposed to eliminate this loophole, so take advantage of it while it’s still there.
3. Paying Down My Mortgage Balance before I Could Pay It Off
When stocks and real estate were plummeting in 2008-2009, I began making additional payments on my mortgage. I thought of this as an alternative to bonds, where I was guaranteed around 4% returns by reducing the interest owed.
The problem with this was that my mortgage payment was not reduced along with this. I still owed the same amount every month, and would need to take a home equity loan to get the money back out if needed or if a better opportunity came up.
The opportunities came in 2011 and 2012. I was investing in rental homes and cash was very tight. If I had not paid down my primary mortgage, I could have probably purchased one more home. Those homes were the best investment opportunity of my lifetime.
Paying off your mortgage produces monthly cash flow. Paying down your mortgage brings little benefit until then.
I paid off my mortgages in full in 2016, which freed up a large amount of cash flow every month. I don’t regret this move and I slept well at night during the 2020 and 2022 stock market downturns because of it.
My general recommendation is to invest as much as you can and as early as you can in stocks and cash flowing real estate—keeping sufficient cash reserves for emergencies and home maintenance—until the day you look up and realize that you could pay off your mortgage in full. Paying down your mortgage before then does not have the same benefit.
4. Buying a Rental Property without Properly Calculating Return on Investment (ROI)
My biggest mistake in real estate investing was the purchase of my first property, a large four bedroom home in a master-planned community near Tucson, Arizona. The home brought some interesting tenants, including one who—according to a neighbor—was arrested by the DEA (Drug Enforcement Administration) while living there! But I digress.
The mistake was not necessarily with the tenants I selected, financially speaking, but with the decision to purchase the property as a rental in the first place. I had no idea how to calculate ROI, and did not realize that the rent I could collect from the property was low compared to the purchase price and the maintenance costs for a 2,600 square foot home.
Similar to paying down a mortgage, a good rental property decision is about cash flow. Instead of thinking about cash flow, however, I was speculating that the price of the home would appreciate quickly. Bad call!
Appreciation is great. It helps the overall ROI, and I benefitted from it greatly on the next three properties that I purchased. But it cannot be predicted as reliably as cash flow, and should therefore be seen as a secondary source of returns rather than the primary reason for an investment decision.
Cash flow is sustainable as a long-term investment strategy. Investing for appreciation without cash flow will backfire.
After learning this lesson, I studied up on real estate. The best book I found is called The Real Book of Real Estate, compiled by Robert Kiyosaki (of Rich Dad Poor Dad fame) after interviewing many experts in their particular areas of real estate investing.
From there, I created a simple calculator that allowed me to purchase the next 3 properties the right way. Those properties have generated great cash flow for the last decade and have appreciated many times over as a bonus!
Enter your email below to receive a copy of the spreadsheet that I use to evaluate rental property ROI.
Summary
I have made plenty of financial mistakes in my life. A few that stand out to me are:
- Not choosing a Health Savings Account (HSA) earlier and investing the contributions
- Not contributing to a mega backdoor Roth earlier
- Paying down my mortgage balance before I could pay it off
- Buying a rental property without properly calculating ROI
And guess what… I still reached financial independence in my 30s!
Failure is part of the process of success. People who avoid failure also avoid success. –Robert Kiyosaki
So don’t worry about making a few mistakes or missing out on a great strategy for several years. You can’t change the past. You can only control what you do going forward.
What financial mistakes have you made? Can they be compensated by good decisions today?
Keep learning and take action when you find something worth doing!
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References
1 https://finaid.org/savings/state529deductions/
2 https://www.fidelity.com/viewpoints/personal-finance/plan-for-rising-health-care-costs
