Recently, a reporter reached out to me with a question: Why do people making a high salary end up poor?
While poverty is relative, making a good salary but feeling broke is more common than many of us realize. It’s something we help clients with at Quorum Private Wealth; we want to ensure that you make the most out of the money you earn.
I shared several common money mistakes high earners make—along with how to fix them—for the GOBankingRates article. But I think we might need a bigger conversation. High earners aren’t just making mistakes that prevent them from becoming wealthy, we see families who’ve already built significant wealth make a few common mistakes, too.
- Getting your emergency fund wrong.
Having savings set aside for an emergency sounds like a given—nearly every personal finance article advises you to create a separate savings fund specifically earmarked for emergencies.
And yet, we still see a surprising number of high earners who don’t have an emergency fund setup. I generally suggest clients set aside three to six months of expenses, depending on the complexity of their financial situation.
What these articles don’t tell you, however, is that sometimes less is more. While not having an emergency fund can jeopardize your long-term financial health, putting too much aside for an emergency can cost you, too. This is especially true if you store the money in a standard savings account, as these accounts offer virtually no returns and rarely keep pace with inflation.
The fix: The first fix is to move any emergency savings to a liquid money market fund, as cash equivalents tend to yield more than the interest on a standard savings account.
If you have access to liquid investments or reliable low-cost credit, you might be able to go a step further, and put less money into a specifically designated fund.
If you have assets in a taxable brokerage account, you may be able to sell investments strategically to generate emergency cash, or, if it makes more sense to stay invested, borrow against those assets at a lower rate than typical consumer credit accounts.
A financial advisor can help you set up your accounts to give you this flexibility and recommend the best course of action if you ever find yourself in an emergency.
- Getting stuck with debt, not leverage.
For young people just starting to earn a high salary, the long hours can sometimes generate a work hard/play hard mentality. It’s easy to get into keeping up with the Joneses mindset of, “I’m making good money, I should be able to spend it on nice things.”
It’s important to be aware of how you’re spending that money, though. A high salary can make you appealing to lenders, who offer giant mortgages or sky-high credit limits that may exceed what you can actually afford, assuming you want to amass wealth for the future.
The fix: Be strategic about debt. In fact, you may want to update your mindset to think of debt as leverage toward a bigger goal. Leverage can make sense when it’s helping you acquire a larger asset or has the potential for significant returns.
Next time you’re tempted to borrow money or charge something you know you won’t be able to pay off quickly, ask yourself: Is this an investment that’s worth the leverage.
If you have any outstanding high-interest debt (such as credit card debt), prioritize paying that down. Then, speak with a financial advisor who may be able to help you access lower-cost credit.
- Leaving money on the table.
Making a good salary doesn’t mean you aren’t leaving money on the table. While most folks know to max out their company 401(k) plans and take full advantage of any employer-match, that’s not the only benefit to consider.
Some employers may match contributions to a health savings account (HSA) as well, provide a Roth 401(k) option, or my personal favorite, offer nonqualified deferred compensation (NQDC) as an option.
It can be easy to miss these benefits amidst the fine print and acronyms, but they have the potential to increase what you “make” now, while also setting you up for success in the future.
The fix: Review your benefits package with a financial advisor to see what benefits you may have missed. If you have an NQDC plan, we can help you navigate the features, benefits, and rules. Depending on your employer-sponsored retirement plan, we may be able to help you access a “mega-backdoor Roth.” We can also help you navigate any conversations with HR to help you take full advantage of what’s on offer.
- Forgetting about Uncle Sam.
Most high earners know that high income = high tax bracket. While you may be able to reduce your taxable income in the current tax year (see previous section on benefits), there’s more to consider.
Keeping the wrong investment in the wrong type of account may cost you both potential returns and potential tax savings.
The fix: Tax diversification and tax location. Tax diversification refers to investing via accounts with diverse tax treatment: tax-deferred retirement accounts (like a traditional 401(k) or IRA), Roth accounts, traditional (taxable) accounts, HSAs (which offer a rare triple tax advantage), 529s, and more.
Taking advantage of these different accounts allows you to go a step further and get strategic with tax location. With tax location, you keep tax inefficient investments, like taxable bonds and credit funds) in a tax-sheltered account. Tax efficient investments—municipal bonds, stocks with qualified dividends or that you plan to hold for a long time, even some real estate funds—should be kept in a taxable account.
- Clinging to a DIY mindset.
If you’re making a top salary or have built significant wealth, chances are, you’re smart and capable. This can translate into a “do-it-yourself” mindset when it comes to managing investments or planning for your future. In our experience, however, this type of thinking can cost you.
It would be nearly impossible to be an expert in tax law, investment management, retirement planning, trusts and estate planning, and the list goes on. Even if you had that expertise, the time required to manage the various aspects, such that you take full advantage of what’s on offer, would likely equal a full-time job.
Plus, for most successful individuals, time and energy are precious resources, and yours are better spent elsewhere.
The fix: At Quorum Private Wealth, we can help you with a comprehensive financial plan as well as investment management. We frequently work with other experts, such as a tax accountant or estate planning attorney, to achieve the best results for our clients.
One thing that sets Quorum apart is our deep bench of industry contacts (we can generally offer referrals to partners and experts when needed), as well as the way we structured our firm to truly put clients first.
If you think you might be making any of the mistakes in this article, or are concerned about risks we didn’t mention, contact us to discuss.
