Let’s explore every financial trap you will encounter on your path to building wealth and how to avoid them. Starting with number one, overconcentration. This is also known as holding too much in one asset and is typically defined as when you have a single stock or an investment in your portfolio that makes up more than 10% of your overall holdings. If your portfolio is worth $100,000 and you have $50,000 in Google stock, that might not be the best idea. When this happens, you are basically betting on one outcome being correct, which is that a lot of your financial future is going to depend on how well Google stock is performing.
Most portfolio managers and financial advisers like to see no single stock exceed 5 to 10% of your total portfolio.
That's a trap on how to invest your money, but what about how you spend it? Trap number two is lifestyle creep. You can see that someone making less than $50,000 per year, 57% of those people say that they are living paycheck to paycheck. But what is crazier to look at is the higher income ranges. 41% of people making over $300,000 a year say they live paycheck to paycheck. And people making over $500,000, so that's half a million a year, by the way. 40% of those people report that they are living paycheck to paycheck, which should be really alarming to you. The true way to build wealth is by keeping your lifestyle cheap and modest while your income increases. When you focus on experiences like going to new places, learning new skills, or simply spending quality time with your loved ones, you will create lasting memories and personal growth that, in my opinion, no items can provide. Whenever you get a raise or promotion, you're going to start to make more money, and you might be tempted to show off that money via your lifestyle. But for your own sake, try not to get involved in this game.
Trap number three is being tax inefficient. Taxes are likely your single largest expense. More than your rent, more than your car, more than anything else that you spend money on.
You want to be strategic about taxes because if you're not, you're seriously just leaving a bunch of money on the table. The most common mistakes are people not taking advantage of tax loss harvesting, holding investments in the wrong accounts, and underestimating how much a capital gains tax bill will actually cost them when they sell a position and for holding investments in the wrong accounts. People put their high dividend stocks in a taxable brokerage account instead of a tax sheltered account like a Roth IRA or an IRA. When you do the former, you actually owe taxes on dividends every time you receive them and that is something that's just inefficient. There are some proactive things you can do to reduce your tax liability. For example, maxing out your 401k, your IRA, or even your HSA. If you are holding stocks, you might want to consider holding them for longer than a year to qualify for long-term capital gains rates. And lastly, learn about tax loss harvesting because strategically selling your positions that have losses in order to offset realized gains could actually reduce your tax bill quite a bit, especially at the end of the year. The IRS will always take a cut of taxes, and your job is to make sure that you're not paying them more than you should be.
Speaking of not paying more than you should, the same logic will apply to your debt. Because trap number four is being lazy about refinancing, even when it could save you a lot of money. If you have a mortgage, the general rule of thumb is that a 1% drop in your mortgage rate is where refinancing really starts to make a lot of sense. Let's say you have a $400,000 mortgage on a $500,000 home and your current mortgage rate is 7%. If you were to refinance to 6%, your payment goes from 26.61 per month at the previous rate to $23.98 per month. and that's about a $263 per month savings that you're going to get. Now, typically refinancing does cost some money. It usually runs about 2 to 3% of your total loan. On $400,000, that could be anywhere from $8 to $12,000 that you might be paying in refinancing fees. Let's say the fee to refinance is $10,000. To break even on those fees, the savings that you get every single month, you need about 38 months to recoup the cost. The key question here is - how long do you plan to stay in your home? If this is your forever home or you want to stay in the home for at least 5 to seven years, a 1% drop in your rate could make a lot of sense. If you're moving in the next year or two, then it probably doesn't make sense to refinance at all. This trap is relevant to anyone carrying a high interest rate, whether that's your mortgage or your auto loan. If you locked in a mortgage or loan during 2023 or 2024 when rates were at their highest, it's probably worth running the numbers right now.
Trap number five is going to surprise you because it's not about money at all. It's about something that you can never get back and that is your time. Because one of the biggest financial traps people fall into when they're building their net worth is that they work too much. This is a financial trap, but also just a general trap for your well-being. In terms of finances, as your net worth grows, your time starts to become exponentially more valuable than your labor. Let's say you have 5 million dollars in a portfolio, and you get a conservative 5% return per year. That's $250,000 per year your money is making. That's $684 a day just from your portfolio. At what point does an extra hour of work start to have diminishing returns compared to what your capital is already doing for you? That's what you should constantly be asking yourself. People who are successful in their careers sometimes are workaholics. Even though they've already made enough money to live a fulfilling life, they already have enough money to perhaps retire early. They still continue working way too much. In fact, one of the top regrets of people on their deathbeds is that they worked too much throughout life and didn't get to enjoy it. Work hard when you're young and you're establishing yourself. But if you're constantly growing your net worth and your portfolio is growing and your income is growing, too, maybe just audit how much you're working, the last thing I would want to see you do is work 80 hours per week and all of a sudden you're at the age of 65.
Trap number six - that is when your finances become too complex. When you start growing your net worth and earning a good income, you may start to diversify your investments into many different places. People will have multiple brokerage accounts, multiple bank accounts, angel investments, private investments, and they might even enter into real estate partnerships. While more than 82% of high earners say they feel confident making investment decisions involving six figure sums, nearly a third of those admitted that they have just pretended to understand a major investment decision despite not fully grasping what they were dealing with. The trap here is that this financial complexity in your portfolio will create blind spots. The more moving pieces that you have, the easier it is to miss a hidden fee, misunderstand a risk, or just make a wrong call.
Trap number seven is being too illiquid or what a lot of people like to call being asset rich but cash poor. This is when the majority of your wealth is being tied up by things that you can't easily access. Let's say you have your entire net worth in your house. On paper, you might look really wealthy, but if it came to investing in a new opportunity, it's not like you can liquidate your house in the next 7 days. For the barely millionaires, households with a net worth between$1 to $2 million, the vast majority of that wealth is illiquid. They typically had 66% of their wealth tied up to a primary home and retirement accounts in 2023. The general rule of thumb is to keep three to six months of living expenses in liquid cash at all times. When you are buying into an asset that ties up your money, you want to think about how long that money is going to be illiquid for. If you're okay with it being tied up for a certain period of time, then that's fine. The mistake people make more often is that they commit money to something that they might actually need in the future and then they find themselves completely screwed when that happens. That's the trap that we want to avoid.
Trap number eight is delaying saving for retirement. And this comes down to the fact that everyone is a little bit lazy and likes to procrastinate, especially deep down inside. One of the most important factors in how much you retire with is not actually how much money you earn, it's how early you can start. Here's how to avoid this trap. Number one, save more. Number two, stay out of debt. Number three, live within your means. And number four - to save at least half of every raise that you earn. That means if you get a raise from $100k to $110,000 per year, you want to put at least half of that $10,000 raise towards retirement.
That's going to serve you really well in the future, and that's an easy rule to live by for any future raises as well.
