Five Dumb Things People Do With Their Money

April 28, 2010 — -- Some days, I get tired of telling people what to do with their money.

You tell them one thing; they do another and then wonder why they have so little.

Maybe it's time for a new approach. Forget about telling them what to do.

Instead, tell people what not to do with their money. Help them avoid the stupid mistakes that can spell financial disaster, and then maybe things like buying a home, saving for retirement and paying for college will be easier.

Toward that end, I've compiled my own list of the worst money moves you can make. The list is by no means exhaustive, as there are an endless number of ways to screw up your financial life.

But avoid these money mistakes, and you'll stand a better chance of achieving your financial goals.

1. Invest in something you don't understand: It's often said that financial products are sold, not bought. That means there's a salesperson behind the transaction, pushing a security or insurance policy that the buyer did not go looking for and does not truly understand.

I'm talking about things like variable annuities, limited partnerships, life settlements or reverse convertibles.

There is a legitimate place for many of these financial products, but quite often their costs are too high and their benefits not as great as presented. Often, the biggest advantage is the commission paid to the broker.

My general rule of thumb is that the less you understand about a financial product, the more it's going to cost you. So unless you understand it, don't buy it.

2. Refuse to sell at a profit for tax reasons: Remember when General Electric fetched $57 a share in 2000 or Home Depot stock approach $70 in 1999? I hope you sold some at the time and paid the capital gains taxes if you held in taxable accounts.

Because you can be sure there were investors who refused to sell simply to avoid paying the IRS. They allowed their investment decisions to be dictated by taxes rather than the investing fundamentals.

The painful consequences of doing this became pronounced during the financial meltdown of 2008 for the owners of bank stocks. For many investors, bank stocks had become legacy investments handed down through the generations. Their values had skyrocketed as banks were bought and sold in a consolidation wave.

Sound investment planning dictated individual investors reduce their holdings, yet many investors refused to sell for fear of capital gains taxes. So now Bank of America shares that peaked at nearly $54 a share in 2006 are now worth about $18 -- after bottoming out at $3 little more than a year ago.

Think there are some Bank of America shareholders who'd be happy to pay some hefty capital gains now?

3. Use retirement savings to pay off a credit card: I hate debt as much as the next person. But some folks become so obsessed about paying it off that they do the dumbest things like using retirement money to pay off a credit card balance.

Now, there's little good to be said about credit card debt, but quite often it's a worse move to pull money out of an IRA, 401(k) or other retirement savings plan to pay off the balance all at once rather than chip away it little by little.

The reason why it's often a dumb move is the early withdrawal penalty plus taxes you pay to pay off the balance. Imagine you're carrying a $10,000 balance on a credit card charging a 15 percent interest rate and that you decide to pull out $10,000 from an IRA to pay off that balance. That move could easily cost you $4,000 in state and federal taxes plus early withdrawal penalties.

Yes, if you drag out repayment for years, you could end up paying that much or more in interest charges. But don't forget the opportunity cost of the lost investment earnings on the retirement balance.

Better to develop an aggressive repayment plan for the credit card rather than make a big retirement withdrawal that will cost you big time come April 15.

4. Sacrifice your retirement for a debt-free graduate: Parents hear the nightmare stories about $100,000 student-loan balances and believe it's their parental duty to ensure their children graduate debt free.

I say think again.

Parents should not sacrifice their retirement security by taking on large college loans themselves and allowing their children to graduate owing nothing. Yes, you should try to keep your child's college borrowing to a minimum, particularly if they plan to enter a low-paying profession.

But the reality is they will have more time to pay off that debt than you do. They will be entering the workforce in their early 20s with more than 40 years of work ahead of them. You might be in your mid-50s with less than 10 years left in your career. Retirement should be your top financial priority.

And how are you going to feel if your debt-free young graduate heads out soon after graduation and borrows $25,000 for a shiny new car while you drive one bought when they were still in high school?

When it comes to financing college costs, my view is the student should have some skin in the game -- not just Mom and Dad. Keep them motivated.

5. Borrow for college and then drop out: There's only one thing worse than a college graduate with $100,000 in student-loan debt. And that is a college dropout who owes $100,000 on college loans.

In this case, the former student (and probably the parents, too) has taken on all the costs of college without realizing the benefits. Sure, college is not for everyone, and some skilled tradespeople can do quite well financially.

But if you and your family borrow heavily for college, make sure you finish. Otherwise, you could be throwing away $100,000 or more that you'll pay for the rest of your life. That's definitely one money mistake to avoid.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is a Certified Financial Planner professional and founder of Four Ponds Financial Planning LLC (www.fourpondsfinancial.com) in Falmouth and Mansfield, Mass. Contact McPherson at david@fourpondsfinancial.com