For better or worse, we Americans are generally left to our own devices to manage our
finances. Maybe it’s because we want the freedom to choose. Maybe it’s because we
don’t trust others to look out for our best interests. Maybe we don’t want companies or
the government to meddle in our affairs.
Whatever the reason, we often find that we are on our own when managing our money.
I suppose I should be grateful for this, since otherwise I might be out of a job!
The expression “Conventional Wisdom” is usually associated with the idea that there
are rules everyone should live by because the crowd is usually right. In personal
finance, there are lots of nuggets of “conventional wisdom” that are sometimes not the
best ideas to follow. Here are some examples:
“The stock market is always the best place to invest”
I’m a huge believer in the stock market’s ability to deliver long-run returns that outpace
just about every other asset type, and for the most part it is a transparent and liquid
market. But “best place to invest” implies that alternatives are inferior. The reality is
that the alternatives are just “different.” Real estate provides stable and consistent returns,
but it is not liquid. Bonds are more predictable and less volatile. Commodities are
sometimes good hedges against inflation. Stocks are certainly the foundation of many
investment portfolios, but time frames, tolerance for risk, and liquidity needs all are
important considerations as well.
“Buying a home is always better than renting.”
People say this a lot, and buying vs. renting is often portrayed as the great benefit
of ownership versus “throwing money away” on rent. First, a home should be
thought of as a place to live, not an investment. Sure, owning is great if you know
where you want to live and that you’ll live there a long time, but there are other factors.
I don’t know of any other investment that requires spending about 5% of its value
every year just to maintain that value, but that’s what you’ll spend on maintaining
a house. If you ever need to change your living or job situation, getting rid of
real estate in a bad market can be ruinous. Also, just getting into real estate
requires a large sum (often 20% of the value) just to acquire it. Almost everybody
purchases real estate using debt, which is heavily influenced by interest rates. Renting,
on the other hand, gets rid of lots of variables and provides flexibility. Rejecting renting
in order to buy a house might not be the best decision.
“Never lease a car. Buy one and drive it until the wheels fall off.”
While this might make the most financial sense for lots of people, it’s not always the
best solution. Your need for the reliability of a newer car might mean buying more
frequently. Perhaps you don’t know what kind of car you need in the long run; leasing
might be a good way to try one on for size. Maybe you just like always having the
newest thing but don’t want to get stuck with a lemon.
“Debt is always bad and should be avoided”
As a former banker, I know a few things about debt. Debt is literally the lifeblood
of capitalism because it moves capital from those who have more than they need
(lenders) to those who need it (borrowers). Nobody you know could buy a home,
and few could buy cars or other big-ticket items without debt. Same with companies;
they use debt to be more productive and profitable. Having debt isn’t without risk,
but so is having no debt. It’s really tough to achieve other goals in life (retirement,
educating kids, simple budgeting) if debt is completely avoided.
“Carrying a credit card balance improves your credit score”
No. Not true. Next topic.
“You should always wait until age 70 to claim your social security”
You can claim your social security any time after age 62, but every year you
delay through age 70, the initial payment increases. Therefore, lots of folks think you
should wait until the last moment to claim the larger payments. That strategy, however,
ignores the fact that if you wait, you are foregoing years of (admittedly smaller)
payments you would be getting. The only way to be sure you are doing the right thing is
to be sure of when you are going to die, and then work backwards. Here’s the
real secret of when to take Social Security: when you take it doesn’t actually
matter that much. Therefore, other factors should matter more like if you have other
income, what your taxes would be, and what the rest of your investments are. It may
be perfectly reasonable to take social security early or late. It depends on your circumstances.
“Financial Plans are always only for the wealthy”
This is like saying that proper diets are only for healthy people, or auto maintenance
should only be performed on Ferraris. Everybody needs to have a plan! Not everybody
needs to hire someone like me, but everybody needs to be deliberate about finances.
You don’t sail across an ocean without doing some navigation, so why are you not
looking over your finances a couple times a year for a few hours at a time? Good
information is all around you, so either take the time to go learn about financial
planning, or hire somebody like me to help you.
“As long as you only take 4% of your investments every year, your retirement funds will always last”
The “4% rule” is handy if you are out for a jog and your mind starts to wander thinking
about retirement; take your investment total and multiply by 4%. That’s what this rule
of thumb says you can take out every year. It’s easy, but it’s mostly wrong. It very much
depends on the year, on what you need, on what kinds of accounts and investments they
are, and how old you are. You might get yourself in a lot of trouble if you blindly take 4%
every year.
“Stocks are always risky”
Back to stocks.
There are all kinds of ways to think about risk. The volatility of the price of stocks is a
risk; you might buy a stock today for $10, but when you need the money, you can only sell it for $8.
Inflation is a risk, too. What if you had $10 in your desk drawer today and kept it
there for 2 years; inflation might erode its value to $9.50 by then. You have lost the
purchasing power of the $10 because you didn’t beat inflation.
Ever think about liquidity risk? Let’s say you pay cash for a $200,000 house but in six
months you need $25,000 of that back for repair costs. The only way you can get
that money out of your real estate investment is to sell the house or take a loan
against it because real estate is not liquid.
My point is only that there are all kinds of risks, and investing involves trade-offs.
Financial planning helps you understand your trade-offs and make decisions about how
to best balance them.
“It’s too early (or late!) to start saving.”
You’re here, now! It doesn’t matter when you did or didn’t start; it just matters that you
start now. Regardless of how you got here, starting now is always better than not
starting now. Your future self will thank you.
In financial planning – just like in the rest of life – there are no absolutes.
Though a short sound bite or TikTok video might be easy to digest, it might not
be right for your situation. The reason I have a job (that for now can’t be replaced by the
AI bots taking over the world!) is that everyone needs different planning, different
coaching and different strategies to address their unique needs, current situations, and
future goals. The variability here shouldn’t stress you out (and doesn’t mean you need
to hire someone like me), but instead empower you with the knowledge that financial
security is not one-size-fits-all. So maybe you take the loan, continue renting, or start
saving now –money should help you live your life to the fullest, not be some kind of
script you need to memorize!