5 Persistent Myths of Personal Finance
Financial experts are full of aphorisms, tenets, and other rules of thumb that are designed to help guide you through the perilous world of personal finance. Although their simplicity can make them quite useful in the appropriate situation, they tend to get distorted and misused over time. Besides, a pithy saying is not a substitute for reasoned analysis, especially when it comes to a subject as personal as your particular financial circumstances. To help protect you from the seductive superficiality of such myths, here are five of the most common offenders.
Credit cards are the root of all evil.
Among many personal finance bloggers, there is a growing movement to eschew credit cards in favor of an “all-cash diet.” Given the inability of many people to limit their spending, using cash for all their purchases may not be the worst idea in the world. However, when used responsibly (a point that can not be emphasized enough!), credit cards can be a wonderful personal finance tool. They make it easy to keep track of your spending and maintain a budget. In addition, many credit cards now offer very generous rewards of up to 5% cash back on certain purchases. In short, credit cards are not inherently evil; it is credit card debt that is the enemy to avoid at all costs.
Buying is always better than renting.
Many people have the impression that renting an apartment or a house is akin to flushing money down the toilet. Why waste money renting, they reason, when you can build up equity by purchasing a home instead? Indeed, buying a home has the potential to be a wonderful investment, but you must consider the risks. First, there are numerous costs associated with home ownership, including sales commissions, interest expenses, property taxes, maintenance, etc. You are also vulnerable to significant price fluctuations. If the last several years have taught us anything, it is that housing, just like the stock market, can fall precipitously in value in a short period of time. At its essence, a mortgage is just a highly leveraged bet on the future of a rather illiquid and undiversified asset. You wouldn’t borrow half a million dollars to buy stock in Apple, so don’t do the same thing with a house without careful consideration.
You can’t put a price on a good education.
An entire generation of young people has internalized a message that has been repeatedly browbeaten into them by parents, teachers, and politicians: a college degree is essential to have a successful career. This common belief has led many kids to take on a mountain of debt under the pretense that the investment in their human capital will ultimately pay off. Unfortunately, this isn’t always the case. For better or for worse, everything – including education – has a price, and that cost is only exacerbated when debt is used as a means of financing. It’s not that education isn’t important – far from it – but such a view is not sufficiently nuanced. It would be nice if the rarefied world of academia was free from such pecuniary concerns. But when tuition is as expensive as it is today, the economics of education cannot be avoided. Philosophy is an important subject that all free-thinkers should explore, but taking on a six-figure debt to major in it could very well shackle you to decades of penury. Epicurus believed that financial freedom was one of the keys to a happy life, a philosophical tenet you should take to heart in your own life.
Blame Starbucks for your inability to save.
If you have spent any time at all surfing personal finance websites, you have probably come across some variation of this paragraph on several occasions: “Instead of getting your daily fix of a $5 non-fat, double-chocolate mocha latte with soy milk, you could invest that money in a Roth IRA and become a billionaire by 30.” This is known as the “Latte Factor,” and it has quickly become one of the biggest clichés in all of personal finance. In the grand scheme of things, your daily coffee habit is nothing compared to the bigger expenses in life, such as a house or car. If you are looking to save money, don’t be penny wise and pound foolish. Instead, focus on the big items and work your way down from there. If you enjoy your coffee and can afford it, just get it and move on with your life. Your latte isn’t going to bankrupt you!
You can never save too much for retirement.
Outliving your savings is rightly considered to be the most significant risk in retirement. This is why financial advisers devote so much time to important concepts like safe withdrawal rates. However, especially among a subset of hopeful retirees who are generally good savers and well versed in personal finance, there is another risk: dying with too much money. For these people, saving for retirement becomes an end in itself, rather than a means to provide consumption in retirement. Unfortunately, dying with the largest bank account doesn’t make you any less dead. Instead, all that extra money represents countless hours at the office that you could have spent with family and friends, working on hobbies, or exploring the world. Assuming you don’t want to leave an inheritance, you’ll ideally spend the last dollar you have on the day you die. Of course, given the uncertainty in life, this is neither feasible nor prudent. But don’t let the fear of running out of money blind you to the value of your time. As in most things in life, the key is balance between the two competing ends.
It’s not that any of these myths are necessarily wrong. For some, these rules should be followed religiously. However, they can become counterproductive when followed blindly by those who are generally on top of their finances. Whenever someone gives you a popular piece of traditional personal finance advice, stop and think whether it applies to your unique situation. In many cases, you will find that it is more profitable to ignore the popular sentiment.