Many of our common beliefs about money come from rules of thumb that have been passed down from previous generations. Old adages, such as pay yourself first and spend less than you earn, have stood the test of time. Other ideas, however, don’t hold up as well today, or were flat-out wrong to begin with. We reached out to a group of personal finance experts to tell us which money myths they believe are the most widely misunderstood. Here are nine of them:
1. Income and happiness
Andrew Hallam, author of Millionaire Teacher, says:
Many people think they’ll be happier with more money or with a higher salary. But studies show that there’s an increase in happiness up to about a $68,000 annual income. Beyond that, added income doesn’t correlate with added levels of contentment. I meet so few people who say, “Yes, I earn enough,” or “Yes, I have enough money.”
But those that do say (and believe) such things tend to be some of the most grounded people I know.
In many ways, the pursuit of “more” detracts from things that are far more important than money, like relationships.
2. Spending in retirement
Manulife financial advisor Kurt Rosentreter says:
All the old retirement planning textbooks said you could expect to live off less than your working income (e.g. 70%). The reality of what we are seeing in the trenches doing this work everyday is that there are three phases: Age 60 to 70 where we are seeing as high as 110% of pre-retirement spending; age 75 to age 85 where costs can drop to 80% after the first spouse death; and costs in the final phase of age 85 onward than can be lower or higher depending on health care. And then there is inflation on all of this – none of the old ways apply to retirement today.
3. Savings rates
Gail Vaz-Oxlade, host of Til Debt Do Us Part, says:
The “save 10%” rule does a lot of people a disservice. If you’re in your 40s when you start accumulating retirement savings, 10% just ain’t gonna cut it. You need to be saving 18% — oh look, the RRSP contribution limit — to stash away enough for the future. But if you’re in your 20s and have heaps of time on your side, as little as 6% all through your life will get you to the same goal.
Speaking of savings rules, investment analyst Ben Carlson, adds:
Saving money on lattes is not how you’ll get rich. Focus on the big picture and not minor things to build wealth.
4. Housing and affordability:
Bruce Sellery, author of Moolala, says:
Mortgage rates – they will NOT always be 3%, people!
Hearing things like, renting is a waste of money! It’s not, it’s a lifestyle choice and as long as you’re happy and you’re investing to build up your net worth, renting is just fine.
Don’t even get me started on the debt service ratio calculations that banks use to qualify people for credit. Why the hell is gross income even on the table? Even after years and years and years of saying, “You don’t make your gross income, you and the Tax Man make your gross income,” no one in the ivory towers has woken up to this reality.
Banks want to see a GDSR (Gross Debt Service Ratio) under 32%. But that’s just for the mortgage. Can you imagine if you have a car payment and you’re shelling out big bucks for day care? And what if you have a whole bunch of deductions off your pay cheque aside from tax: CPP, EI, union dues, retirement savings, medical benefit premiums, and the like. Is it any wonder that people turn to credit cards and lines of credit to make ends meet?
It’s gotten to the point where the banks don’t even use your “credit limits” to calculate debt service anymore, now they use minimum payment amounts. Lord love a duck!
And Carlson adds:
It’s a myth that housing is your biggest investment. I consider it an asset, not an investment.
Jonathan Chevreau, Financial Independence Hub, says:
I’m not sure the “Bonds should equal your age” rule of thumb still stands up, given both the record low interest rates and expectations for rising life expectancy.
And I keep hearing the saying “you can’t time the market” yet every time I go to financial conference someone is selling essentially a market-timing service. The message seems to me “Most people can’t time the market — except us.”
‘You get what you pay for’ manifestly does not apply to the age-old investing debate about active vs. passive funds and fees.
And you could predict that it bugs me that most of the industry’s wealth accumulation focus is geared to something called Retirement, when Findependence is a better goal.
It’s a myth that your investment strategy will separate you from other market participants. There are many decent strategies, but discipline matters more than strategy.
Also, we always hear that for every winner in the market there’s a loser. But that doesn’t take into account time horizon or reasons for buying & selling.
Investment returns – 7% might be accurate for the equity portion of your portfolio over time, but with a balanced portfolio it might be aggressive.
6. Safe withdrawal rates
Justin Bender, Canadian Portfolio Manager, says:
The 4% rule is kind of irrelevant – I feel as though it gives investors the sense that they don’t need to plan as long as they just take out 4% each year (and increase it by inflation).
Investors who focus on the amount of dividend and interest income the portfolio is expected to receive each year may make poor investment choices. For example, a portfolio that is managed from a total return and tax-efficient basis would be expected to have very low current income (usually around 2.5%). An investor who sees this 2.5% yield may incorrectly assume that since they are not receiving 4% each year, that they will run out of money in retirement. They may then look to take on more risk or change their tax-efficient strategy into a tax-inefficient one.
7. Life insurance and disability insurance
A common belief is that you don’t need life or disability insurance because your company group plan has it. Almost no one has private disability coverage because they rely on the corporate plan – not realizing that almost all corporate group plan coverage is almost no coverage at all, rarely covers all their income, may only pay for two years and you lose it if you quit or are fired.
8. Estate planning
Lee Ann Davies, founder of Agenomics, says:
The one that makes me squirm is to put the adult child on the title to the parents’ home to avoid taxes at time of death. There are numerous problems with this including risks for the parents that they are sharing title but also the loss of the capital gains shelter when it’s not a primary residence for the child.
9. On Rules of Thumb
I wrote a book about this – Money Rules – where I debunk some of the “rules of thumb” we’ve been told to live by. We aren’t all thumbs. Some of us are little fingers, some index fingers, and so I give the middle finger to the one-size-fits-all rule of thumb.
I am a fan of rules of thumb. Even if they aren’t totally accurate, they give people a way to start thinking about things. Seen in that light, as a starting point, I think they are very helpful. It cuts through the complexity of personal finance (i.e. fixed income = age). Sure that is a very broad rule of thumb, but it is a starting point.
If we could JUST get Canadians to the starting point we would be so, so much better off.
Readers: Do you have anything else to add? What rules of thumb do you abide by and which ones do you wish would disappear for good?