Monday, July 23, 2012

What's the worst financial advice you've received?

If you’re looking for an overly-simplistic personal finance book that could have been written by any reasonable person, but instead was written by two Harvard MBAs (because you know, concepts like ‘if you save no money, you will be poor in retirement’ are advanced and as such clear only to those with graduate degrees), look no further than Thakor and Kedar’s ‘On My Own Two Feet’.  Maybe I’m just a hater, but I found the level of financial advice to be so basic as to be nearly useless.  And the worst part – on top of that, they gave terrible advice!  According to them, if you’re under 50, you should invest 100% of your money into stocks.

The reason people invest their money is not because it’s easy or safe or returns are guaranteed.  Rather, we are living longer, don’t have pensions to depend on, and need to at least partially finance our retirements and other goals (like paying for our kids’ education).  Due to this painful thing called inflation, our money is actually worth less over time.  One thousand dollars today are worth $740 in 30 years at 1% inflation if you stick your money under a mattress.  Inflation in the US has historically been around 3%, so your $1000 would be worth around $410 in 30 years if you did nothing.  Savings account, MMAs, or CDs guarantee a small interest rate – currently at a historical low.  So, if you stick to the safer savings accounts, it’s a struggle just to even match inflation to ensure your money is worth as much in the future as it is now.  On top of that, many of us rely on our investments to return above inflation, so that our money grows.

Many things that are awesome aren’t easy – returns don’t come without risk.  When financial advisors or articles refer to the power of compound interest, and the necessity of investing, they’ll throw out assumptions like 6% returns every year in order to get to those big, impressive numbers for what can happen when you invest $200/month for your entire twenties.  The problem is these assumptions are based on historic returns in the US.  And they’re based on averages – returns tend to fluctuate significantly, and frankly though past returns may be our best guess for what happens in the future, past returns don’t predict future ones.  Also, Japan anyone?

I’m sure you or your parents of someone you know lost a ton of value from their portfolio in the last 5 years.  It sucked, but it will keep happening.  While I cannot predict future returns based on past performance, I can guarantee that stocks will rise and fall in value.  And what does everyone say you should do when you lose 40% of your portfolio due to a steep decline in the stock markets?  Buy more!  It’s a sale, it’s cheap, it’s going against the cultural grain, and frankly our human nature.  And also? It’s hard, which is why people who understand the logic of buying low and selling high, often can’t fully comply with that mantra.  Stocks have historically (in the US) produced higher returns than bonds – at the cost of higher volatility.  So advising people to put 100% of their investments into stocks means setting them up for some really difficult times emotionally.

Please promise me, oh wonderful friends and readers, that when the day comes that you want to discuss your money & plans with a professional, you remain calm if they suggest an asset allocation without giving you a risk survey to fill out.  Simply ask for a glass of water, then throw it in their face!  Seriously, someone’s allocation doesn’t depend simply on how much they “need” their money to grow in order to fund retirement or whatnot.  The amount of money you’re going to spend on a house isn’t determined by how much space you “need”, but on what you can comfortably afford. AKA if you’re eating ramen to afford your mortgage, something ain’t right. (But if you’re eating ramen because it’s delicious, that’s totally cool.)  An allocation may not be right for you if you stay awake at night and stress over the short-time fluctuations in your portfolio.  Some worry is unavoidable, and most of us can’t afford not to invest (so suck it up), but your risk tolerance is clearly going to dictate how much you feel comfortable putting in stocks.

I think the reason so many personal finance books are blah is because they over-simplify and placate the people with loads of credit card debt and a string of bad past decisions.  (Yes, I get it, you don’t want your readers to feel bad about themselves, because they won’t like you, but some people may need the rude awakening and don’t need the false comfort – because I said so.)  Equally important, many books miss the mark on why any of this (your credit score, your savings rate, investing) is at all important – because you want to be free to do what you enjoy, you want options.  Telling people they’ll save tons by skipping their daily latte is not cool – some people really enjoy a hot, overpriced drink – why would you give it up, unless doing so paved the way for something even better?

I honestly haven’t received any terrible financial advice, unsurprising given how taboo the topic is.  Although I would think twice before listening to the jerk that claims paying off your mortgage early is a terrible idea – yes, you can invest elsewhere (but those returns aren’t guaranteed) and you can write off your mortgage (but only if you itemize and only at your marginal tax rate).  My financial advice would be to figure out what you love, then quit spending money on the crap that doesn’t really matter.  As for life advice – steer clear of women who hate other women.  Then you’ll pretty much be set.  It’s working well for me.

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