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:
- 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.)
- 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.
- 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?
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, few blogs are better inspiration than Chris Guillebeau’s Art of Non-Conformity. Chris’s recent 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.