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10 Astonishingly Common Misconceptions About Money

Misinformation is dangerous. In medicine, it can kill. With money, it can cost us millions in a lifetime. So if you believe any of these 10 things, stop!

When what you think you know about money is a mirage...Lots of people have some pretty big misconceptions about money. Some of these are perpetuated by financial media. Many of them are dangerous.

Are you guilty of any of these? If so, let me know in a comment and tell me why you believed it.

1. “Cookie-cutter, set-it-and-forget it mutual funds are for suckers. I should be actively trading with my portfolio.”

Here’s the thing: Most professional money managers, even those with Harvard MBAs and 20 years of experience, fail to beat the average returns of the overall stock market in the long run. Why do you think you can you do it after reading a couple of books?

For the average investor, actively trading will reduce your overall returns and eat away at your money with trade commissions. Low-cost index mutual funds provide a better option; ETFs are fine, too. Does that mean you should never trade funds? No, savvy investors should learn to hold a mix of funds tracking stock and bond markets and rebalance those as markets move and you get older. But forget reading the Wall Street Journal and trying to find the next Apple.

2. “Only rich people can invest.”

You don’t need $1 million, $100,000, or even $10,000 to start investing. A couple hundred bucks does the trick. And when you combine that with a few dollars a month for the rest of your career, guess what? You won’t be poor. Investing doesn’t have to be complicated (see #1); you just need to take the plunge.

3. “I don’t need to worry about retirement (yet).”

I will be the first to admit that there’s very little joy in saving for retirement. Even though 401(k)s and IRAs have tax advantages, it feels like I’m saying goodbye to my hard-earned money for a very, very long time. I won’t retire for 35-40 years.

At the same time, I understand the importance of putting away for tomorrow. Pensions are gone. I don’t trust that social security will be around in 40 years and, if it is, it will not be enough. We’re living longer, which means more years of income to replace and more medical bills.

This stuff is hard to think about in your 20s and 30s. Choose to deal with it now anyway. It will make a huge difference in later life.

4. “All debt is bad.”

There are three ways to look at debt:

  1. The financially inexperienced see debt as “free money” that they can spend with impunity today and worry about tomorrow. (This was me in my early 20s.)
  2. When it’s time to pay the piper, people realize the debilitating effects of too much debt and begin to see debt as an enemy of financial progress.
  3. A third type of person sees debt neither as a free pass to spend nor a set of shackles to bear, but a tool that provides leverage. It’s a sharp tool that can be dangerous, but when wielded carefully, makes the job of accumulating wealth easier.

Most successful people belong to group number three.

For example, a mortgage enables middle-class people to own a home and pay it off at a modest interest rate over time. This frees up their cash to invest and enjoy life. Small business loans can allow somebody to grow a new source of income. And larger businesses borrow money to finance expansions while preserving cash for day-to-day operations.

Coming out of a huge recession, many of us are more inclined to be wary of debt. Meanwhile, savvy people are using it cautiously to grow businesses, buy real estate portfolios, or simply make their money go further. How can you adopt this mentality? Put simply, after you pay off any credit card balances, start investing (and even enjoying some money now) before paying off mortgages and student loans early.

5. “Debit cards are superior to credit cards.”

When you wake up with a hangover, you might swear you’re done with alcohol. But a couple of drinks won’t usually give you a hangover; a dozen drinks will. So if you’ve gotten into trouble with credit cards, you might decide that sticking with debit cards is the safe way to go; you can’t spend money you don’t have in your bank account, right?

Unfortunately, debit cards carry a lot of risks, so I’ll always choose credit cards for everyday spending (paying off the balance each month, of course).

Most credit cards provide greater purchase protection, rewards and fraud protection than most debit cards. Credit cards also help build a good credit history which helps with everything from future loan approvals to employment background checks.

And finally—something that not a lot of people talk about: If you get in a pinch and need to spend money you don’t have, paying interest on a credit card is often less costly than a single debit card overdraft charge (provided you repay the full amount quickly). Example: Overdrawing your checking account by $200 might cost $39. Carrying a $200 balance on your credit card for one month at 19.9% APR will cost about $3.30 in finance charges. Even if the card has a minimum finance charge of $5 or $10, you’re better off.

6. “Everybody needs life insurance.”

You don’t need a PhD to understand life insurance, but the insurance industry sometimes takes advantage of consumers’ lack of knowledge to sell overpriced products that you may not even need. First, you only need life insurance if you earn income that somebody else relies on. For example, if you’re married and own a home with your spouse and you rely on both your income to make mortgage payments—even part of them—you probably need life insurance. If you have kids, you definitely need life insurance.

In 99% of cases, the only life insurance policy a young person should buy is level term life insurance. This works just like car insurance: you pay a annual premium for a set amount of year and the insurer only pays a benefit if you die in that time period. (For example, you might pay $500 a year for 30 years; if you die any time in that period, the insurer will pay your beneficiary $1 million.)

Insurance salespeople make other policies look attractive because you either get some money back if you don’t die or the policy accumulates some cash value like a savings account. These features are tempting, but the policies end up costing more. You’re better off keeping the extra money and investing it on your own.

7. “Your home is a good investment.”

Recent real estate woes have deflated this notion somewhat, but I still hear people talking about buying a home because it’s a good investment. If you’re lucky, then yes, your home will appreciate before you sell it. But for most of us, we will sink lots of cash into maintenance and upgrades that we won’t recoup when we sell.

For most of us, our home also represents a big percentage of our net worth. No sane financial advisor would tell you to plunk 80%, 50%, even 25% of your assets into a single stock. But that’s essentially what you’re doing if you treat your home as an investment. You’ve got all that money tied up in one piece of property. Risky.

If you want to invest in real estate, buy a rental property or invest in real estate securities (REITs). If you want a hassle-free place to live, go rent an apartment. But if want a place to which you will devote your heart, sweat, and spare cash, then you should buy a home.

8. “The way out of debt is to cut back and spend less.”

When I got into debt, I tried for two or three years to chip away at it by cutting down my spending. I tracked every penny. I moved back home with my parents. But my impulses got the best of me. I’d be good for a month, and then I’d blow it, spending a bunch of money.

Being broke sucks. What sucks even more is being broke and trying to spend even less. That’s why, whatever your financial goal, you’ll get further faster if you turn your attention to earning more. Combined with a reasonable budget that keeps spending in check, you can get out of debt, get some financial stability, and you’ll come out of it earning more money. What’s not to like?

9. “Financial professionals must always give advice that’s in my best interest.”

This is an important one. Financial professionals like your loan officer at the bank, insurance salesman, or the financial advisor selling you mutual funds, all present themselves as  trusted partners in your financial plan. But its these people’s job to sell you products: mortgages, insurance, and investments. These products earn money for them and their companies.

True, few of these people are trying to harm your finances, but you must realize that when you’re dealing with them, they’re looking out of their bottom line, perhaps before yours.

If you need professional help with your finances, seek out a financial planner that has pledged to serve as a fiduciary. This means they must put your financial interests first. You can’t avoid dealing with the other guys, just be aware of their motives and do your own homework.

10. “I can’t afford to buy a house/take a vacation/start a business/go back to school/do what I really want.”

If you’re dream of the nomad lifestyle or quitting your day job to do something you love, Chris Guillebeau’s post about 34 lessons about travel and adventure has some good nuggets about money. Namely: Money does buy happiness, but only to a point. Figure out how much money you need to do what you want and and focus on income rather than expenses. Don’t accept a “poverty mindset” that you’ll always be poor.

This kind of thinking does NOT have to be at odds with financial responsibility. That’s the goal of my Richer By The Week goal-setting workbook and much of what I write. When you prioritize and plan, you can spend intentionally on the things you love.

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. Great post David. I am most guilty of #2 & #3. I had always put off investing thinking I didn’t have enough money to put into it. Instead I put any savings into my retirement fund where I am likely to earn much less money. That makes it sound like I am concerned about my retirement savings, but I realize I just haven’t been contributing enough money there. I was in the mindset that I had plenty of time to save for that and I would likely be able to afford to save easier as I got older. If I had instead been serious about that for the last 10 years or so, I’d have much, much more saved.

  2. Great post. I thoroughly enjoy your blog, as it always has practical advice and actionable items. Thanks for your insight, even if my recent 30th birthday ages me out of your targeted audience!

  3. Great post!! Guilty of #2 and #3. I met a financial advisor recently and was told that anything less than 100k is a waste of their time! I need to educate myself better and start investing.

  4. “First, you only need life insurance if you earn income that somebody else relies on.”

    Just another point of view on this one – besides shared mortgages, there are other reasons to get life insurance even if you are young and have no kids. While it technically falls into “other people depend on your income”, I have a life insurance policy with my dad (not my husband) as a beneficiary. Why? Because I also have a large student loan that my dad cosigned. If I die, I want him to be able to get the money right away so he’s not stuck paying $600+ per month waiting for my husband to transfer him $100,000.

    I get the policy through my employer, however, so it only costs me a few bucks per paycheck.

  5. Hey David,

    You hit the nail on the head when you said:

    ” Most professional money managers, even those with Harvard MBAs and 20 years of experience, fail to beat the average returns of the overall stock market in the long run. Why do you think you can you do it after reading a couple of books?”

    I think that is why I just choose not to participate in the stock market all together. I’m not hating on mutual funds or other stock market strategies, I just would rather control my investment.

    Generating 10-12% cash on cash returns pretty easily with today’s real estate market. If someone really takes the time to get an education 20%+ returns are also attainable.

    Coupling a fix rate mortgage (~5%) with a cash flowing rental, provides a great return and basically gives the average person a way to “short” the dollar over time. Just my 2 cents.

    Great post!

    AG

  6. Excellent post. You could have easily spent weeks hitting each topic.

    I am not in agreement on the “buy a house” one. I won’t deny that for some renting is the superior option, but it’s a poor option for most people. Buying allows you to lock in a big part of your housing costs at today’s prices; one of the only expenses you’ll ever have the option of doing. It also happens to be the biggest expense for people. It’s no riskier than mutual funds.

  7. I really hope #7 is true for me. I’m putting a lot of sweat equity into my new home to make sure it is.

  8. Great points David. I too know a lot of people who are constantly trying to beat the market. I believe that if someone is able to max out their retirement accounts and invest in low cost mutual funds, it is only then that they should be tinkering with a taxable account.

    I do still think that all debt is bad debt. Though you’re absolutely right about using debt as a tool to buy a home or help accumulate wealth, I think it’s in a persons best interest to rid themselves of the debt as soon as they are able to.

  9. Great list! Probably most salient to me is stock investing. I’m in funds for my retirement scheme but would like to start investing in a few more outside of that, independently.

  10. I think that there is more to #1. The best method that I have found is to find a balance between active trading and blindly dumping money into mutual funds regardless of market conditions. Beyond rebalancing porfolio mixes between equities, bonds, and cash, once in a while, I think it is also prudent to pay attention to when you are allocating money to which fund.

    One of the most fundamental investment failures that the average Joe makes is buying high and selling low. It’s not a concious decision, but an unintended emotional backfire. People only want to buy when the market is in the midst of a rally, and then get scared during a pull back and sell. In effect, they bought high and sold low. If you can remove emotion, take a contrarian view of the market, and do the opposite of the general trend, you will be much better off. Buy when everyone else is selling in panic (you know the market won’t go to 0) and then be the one selling during the rally when all of the average Joe’s are buying back in (you know a rally can’t last forever). Remember, pigs get fat and hogs get slaughtered.

    I’m not advocating day trading or anything like that. Nor am I suggesting that you not regularly contribute to your 401(k) or IRA. What I am suggesting is that you consider where you allocate your monthly investments and where you keep what you already have invested. If the market has been rallying for a while, why not reallocate most of your money from equity (stocks) mutual funds and move them into a low risk bond fund, essentially selling high and locking in profits? When the rally ends and the market has seen a solid pull back, then move out of the bond fund and back into the equity fund, esentially buying low.

    You will never perfectly time market bottoms or tops and you shouldn’t try to. You will end up moving out of equities before it tops out and you will end up moving back in before the market bottoms out. However, you will be able to reduce the impact of major market fluctuations in your portfolio. Look at the average equity mutual funds over the last 10 years, $10,000 invested in 2002 is still about $10,000 today. It may have made it up around the $20,000 mark in 2007, but fell to $6,000 in 2009. Had you reallocated that money in say, 2005/6 out of equities at $16,000 and then moved that same $16,000 back in at the end of 2010 when the market stabilized and started moving back up, you would be looking at around $20,000 today. That assumes that you missed the absolute top (2007) and the absolute bottom (2009).

    You have to pay attention to major market trends, there is no getting around that. The mutual fund managers will put you into the best stocks available, but they are still bound to invest in sotcks and no matter how smart they are, they can’t get around a bear market (yes, I know there are specialty funds that can, but most funds offered in 401(k) plans are designed to track a market index like the S&P 500 or Dow-Jones). So why not watch the news every now and then to keep an eye on the overall market trend and reallocate your funds 2 or 3 times a year? You still make the monthly contribution, taking advantage of dollar cost averaging. But if there are major shifts in market trends, say 6 straight months of growth, why not move some of those funds to a bond fund or money market and lock in those “gains”. And when the market has a major pull back for 2 or 3 straight months following that rally, then move the funds back into the equity mutual fund, essentially buying low. You don’t have to be a Wall Street banker to know when major market shifts are underway, just pay a little attention and reap some big rewards….

  11. A little talk about #7….

    A home IS a good investment most of the time, but for reasons that you don’t discuss. If you plan to stay put for 10+ years, then you should buy a home. Never buy your main home as a financial “investment”… always buy it as a home to live in for a long period of time… to raise kids, to have stability, to feel comfortable in and to have ownership in.

    Remember, when you rent, 100% of your money goes down the drain and goes to someone else’s equity. When you buy, if the market doesn’t absolutely tank on you (which most of the time it won’t), at least you know you may get SOME money back when you move. And you can do whatever you want with your home and you don’t have to move when your lease is up. There is a LOT of value with that.

    I’ve both owned and rented for many years of my life…. homes, apartments, etc. Buy a house for you and your family to LIVE in long term…. that is the investment.

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