Sometimes we say or believe things about money because it’s what we’ve been taught. It’s what we’ve come to hold as true.
Perhaps, your parents told you “renting was a waste of money”, and “if you want to be a ‘real adult,’ you have to buy a home.”
Or, maybe you grew up thinking college was the only way to have a successful career because it’s what you heard from teachers, parents, and friends your entire life.
There are many things people say and believe about money simply because it’s what they’ve come to know as true. No facts, no research, just unquestioning belief.
Here are six of the more ridiculous things people say and believe about money.
1. “I bought a house for the tax deduction”
There are plenty of other ways to take advantage of tax deductions, ones that don’t require a large down payment and a 30-year financial commitment.
Okay, so it’s rare someone buys a home just for the tax deduction. What usually happens is someone is already looking for a home and uses the “tax deduction” as justification for buying more home than they can afford.
The self-deception works because it’s grounded in truth: you do get a tax deduction. But, it’s a half-truth.
What if I framed the tax deduction another way and said, “Hey, I’ve got a deal for you. Spend $100 more than you should and I’ll give you back 25 bucks. So, in the end, you’ll only spend $75 than you should.”
Spending a dollar to save a quarter doesn’t make sense. In fact, it’s ridiculous.
2. “Renting is a waste of money”
This debate has been going on for forever and shows no signs of stopping anytime soon. While many people adamantly believe it never makes financial sense to rent instead of buying, this is simply not true.
Choosing to buy or rent comes down to a number of financial calculations and lifestyle choices.
Do you plan to stay in your home for a long time? Do you like to move around? Do you want to take on the risk and responsibilities that come with homeownership? Do you have enough money saved for a downpayment? Can you afford all of the extra costs associated with homeownership (maintenance, property taxes, utilities)? What is the housing market like?
It’s the answers to these questions (and many others) that will help you make an informed decision as to which route is best for you.
The next time someone tells you “renting is a waste of money,” ask them to provide the answers to the questions listed above. They won’t able to. You can then tell them how ridiculous they sound.
3. “I don’t want to make more money because I’ll have to pay more in taxes”
Wait … let me get this straight. You want to forgo a big raise at work because you don’t want to pay more taxes? You lament getting a bonus because “it’s taxed at a higher rate?”
Some people are afraid to make more money because it will “push them into a higher tax bracket” and, presumably, means less take-home pay because of higher taxes. That’s just not how this works.
Making more money may indeed push you into a higher tax bracket but this does not result in less take-home pay.
In the U.S., we have a progressive tax system. This means as we make more money, we’re taxed at progressively higher rates. But, here’s the important part: you only pay a higher rate on the portion of your income that has moved into the higher bracket.
This means your original salary will NOT be affected by the “bonus” and only the new money will be taxed at a higher rate. Yes, you will be paying a higher rate on the new money, but it doesn’t affect all of the money you’ve earned.
Bottom line: it’s ridiculous to make less money just because you’re worried about being bumped up into a higher tax bracket.*
*Note: this is not to be construed as tax advice. Consult with your accountant about your specific situation.
4. “A college education is always worth the money”
It’s true. A college education is often an important step in finding a good career. In fact, many companies require a degree just to get a foot in the door. But, things are changing.
Today, many of the leading tech companies like Google and Apple don’t require employees to have a college degree. Instead of looking for “credentials,” companies are focused on whether or not you can do the job.
Additionally, many of the trades don’t require a college degree and offer high starting wages, union-quality benefits, and higher job security. In fact, the trades can’t find enough young talent to take these quality jobs.
In contrast, the thirst for a college education, and the high price tag that comes with it, is running on all cylinders. Student loan debt in America sits at $1.68 trillion. The average federal student loan debt is $36,520. Student loan debt is growing at a rate 6 times faster than the national economy.
This is staggering.
Part of the blame falls on predatory colleges. Part on consumers.
We can’t control what colleges do, but we can control how much debt we take on and what degrees we’re getting for that debt.
Taking on $80,000 in student loan debt to get a degree in a low demand, low paying field is a terrible financial investment.
College is a wonderful thing for many, but not all. It’s not always worth the money, and it’s not always worth the debt. The financial cost of getting a degree can’t be greater than the financial benefit. Too often we forget this and simply go with the old trope “an investment in your education is always worth it.”
5. “To determine your stock allocation, subtract your age from 100”
It can be challenging to figure out how much of your long-term investments you should allocate to stocks. To help with this decision, a simple rule of thumb grew popular in the 1970s and ‘80s and persists to this day.
The rule: subtract your age from 100 to determine your stock allocation.
For example, if you’re 40 years old, subtract your age (40) from 100 (100-40) and that tells you how much to contribute to stocks (60). This means 60% of your money should be allocated in stocks and 40% in bonds.
This rule of thumb has stuck because it provides a simple answer to a complicated question. And, logically, it kinda makes sense. It follows the fundamental investment principle of matching your level of risk to your time frame. This crude formula does this.
The formula is: 100 – age of investor = % in stocks
Going back to our example, of the 40 year old investor.
100 – 40 (age) = 60% in stocks
If the investor is 70 years old:
100 – 70 (age) = 30% in stocks
According to the formula, if you’re 40 years old and have a longer investment time frame, you’d invest 60% of your money in stocks.
But, if you were 70 years old and have a shorter time frame, the formula says you should only invest 30% of your money in stocks.
This matches the basic principle of investing more in stocks if you have a longer time frame and less if you have less time.
So, it fits the pattern of: older means less money in stocks
Unfortunately, outside of this weak correlation, there’s little validity to the formula.
In general, the formula is too conservative for younger investors. In the example above, the 40 year old investor allocates 60% of her money to stocks. For many investors, this is far too conservative especially for women who have longer life spans. It also doesn’t allow for an investor to be 100% invested in stocks irrespective of her age. How can that be the rule?
As humans, our brains have developed to seek the simplest, quickest answer to the question even if the answer isn’t exactly right. This is fine for avoiding sudden, physical danger but doesn’t work well for complex, intellectual problems.
The formula of subtracting your age from 100 and investing that amount in stocks is painfully inadequate for solving such a complex problem.
6. “You should have 5 times your current income in life insurance
Here we go again with using the simplest of solutions for a complex problem.
People like rules of thumb and heuristics because it means we don’t have to think so hard. The math of “5x your income” is a lot easier than working through an actual financial analysis.
How much life insurance you need is a function of what you want your life insurance to cover.
Here are a few questions to consider:
- How many years of income do you want to replace? One, five, ten, twenty years?
- What debts do you want to pay off? The house? The cars? Any and all debt?
- Will your spouse continue/go back to work? How much income can he/she expect to make? Does he want to take time off to be with the kids?
- What future goals do you want to fund? College, weddings, retirement?
- Will you remain in the same house? Downsize? Move back home?
You can see why people are quick to latch onto an answer like “buy 5x your income.” It’s simple and you’re doing something. But, you’d have to get awfully lucky for it to be the right answer. Chances are you’re either overinsured and paying for something you don’t need or you’re underinsured and unknowingly putting your family at risk.
It treats everyone the same. It doesn’t account for marital status and number of dependents which is ridiculous. Should my business partner who is single and has no dependents have the same amount of life insurance as me who has 6 dependents?
Remember, personal finance is personal
When you hear people say things like, “You should always do this” or “You should never do that,” take it with a grain of salt.
Everyone’s situation is different. One person’s ideal financial decision could be another person’s worst decision. Rules of thumb sound reasonable on the surface, but quickly fall apart and can reach “ridiculous” status when under increased scrutiny.
You work too hard for your money to leave things to chance. Be inquisitive and don’t be afraid to challenge long-held beliefs even if you feel a little ridiculous in the process. Chances are you’re on the right track.