Five Common Personal Finance Tips That Are Just Plain Wrong
Sherry Hao, Controller, U.S. Money Reserve
You’ve probably heard hundreds of “rules” for managing your money the right way. Here are the ones that make the most sense in the modern era.
Parents just want their kids to make good, smart, and beneficial decisions when it comes to finances. Financial advisors, well-meaning mentors, and even personal finance experts want the same thing. They want to ensure that we’re all making the right financial decisions for our future. Yet so many of the things you see, hear, or read about how best to manage your personal finances are just plain wrong in today’s volatile and changing market. But how do you know which advice to follow and which to throw by the wayside? After all, entire books and media empires are built on the backbone of some of this advice. How could it be wrong?
The truth is that most advice you see out in the world is broad and generic — almost to the point of being useless. Sure, buried under the platitudes and catchy book titles are some elements of good, solid financial advice, but to take good advice to heart, you have to understand how it impacts you. Here are some common financial platitudes that just don’t hold up in today’s world.
The “Latte Rule” Is Bad Financial Advice
Back in the early 2000s, David Bach, a talented personal finance author, coined the term the “latte factor.” He made such a compelling argument in the book The Automatic Millionaire that he recently released a book focused exclusively on this topic, entitled The Latte Factor. The idea behind the advice is solid and totally accurate, but it needs a bit of reframing to make sense in the current era.
Here’s why: The “latte factor” is a way of identifying those small things that you spend on every day. Usually, those expenditures included things like coffee, lunch, or an afternoon snack when we were working in offices. The idea behind calling out the “latte factor” is to help people who struggle with finances become more aware of their unconscious spending habits. Credit and debit cards make spending money a lot less visceral, so Bach wants to call attention to the things that we don’t really think about when we plop down our cards. The idea behind his theory is that if you don’t feel the cash leave your hands, it doesn’t feel like you’re spending money each day, even though your accounts dwindle.
The core idea of the latte factor is sound. One of the first steps to get spending under control is to get a handle on all those little cash leaks that happen each day, week, month, and year. Maybe it’s your music subscription. Perhaps it’s for a service or software platform you no longer use. Perhaps one of the subscriptions you have recently raised its prices and is taking a more significant chunk out of your income. Whatever your small spending habits, it’s essential to gain awareness of them so that you can adequately manage them going forward.
The problem with the “latte factor,” however, especially in this moment, is that because of COVID-19 and the global pandemic, we are no longer spending on things like lattes — or really most of those small unnecessary things that we pick up when we’re out interacting in the world. For one, a majority of businesses are still closed because of the pandemic and social distancing guidelines. Second, as the economy struggles along at partial power while the world fights the ever-elusive virus, people are cutting back on more expensive and less necessary items. Finally, Bach’s math was a little bit off.
According to a piece over at Slate, if you did cut out your daily latte and saved that money or put it in the stock market instead, experts estimate that you could end up with as little as $50,000 or as much as $100,000, but not the million dollars that Bach claimed. The math doesn’t add up. Even Sallie Krawcheck, former president of the Global Wealth & Investment Management division of Bank of America and current CEO and co-founder at Ellevest, says that the latte rule is “bad financial advice.”
Instead, it pays to think about your priorities as you examine your spending habits. Do you get joy from purchasing a latte? Do you get pleasure from paying for a monthly streaming subscription? Do you use it regularly? What are you giving up to buy these items? What other priorities do you have for your finances? These questions are key to understanding where your priorities lie when making sound financial decisions. While the latte rule is a good idea (and a nice sound bite), take the math with a grain of salt. It turns out it’s totally wrong.
“Build Your Emergency Fund, Then Pay Down Debt” Is Unsound Advice
We’ve all heard the advice to be sure we have three to six months of money saved to cover our basic expenses for a rainy day, right? In today’s world, that may not be realistic nor practical. Here’s why.
First, the cost of debt — especially credit card debt — is astronomical. Some cards charge as much as 20–30% in interest. Some even climb as high as 36%! That kind of interest charge can really add up — and there’s no chance that stashing your cash in a savings account will even come close to earning that kind of interest today. In fact, most savings rates are hovering under 1%. It makes better financial sense to pay off those high-interest credit cards as soon as possible, rather than letting them linger and continue to accrue interest.
“Don’t Choose Individual Stocks” Is Flawed Advice
You’ve probably heard the adage that you shouldn’t choose individual stocks dished out on financial talk shows or segments on early-morning television. While there is some sound reasoning behind the advice, it’s not the best financial rule of the road out there.
You’ve probably seen many headlines that tout the value of getting into the market right now because it is so volatile. However, volatility isn’t necessarily a good thing, especially if you are a new or don’t have a very diversified portfolio. Trying to time the market at any point is just plain difficult, and there’s a high likelihood that you’ll get it wrong, no matter how much research you do. That’s because market volatility is primarily tied to group human psychology, which often cannot be predicted. Trust me; if there were a legal and reliable way to time the market, you can bet that everyone would be doing it.
That being said, there are quite a few pros to choosing individual stocks even now. As Investopedia points out, you won’t pay as many fees when choosing individual stocks since there aren’t any management fees to have someone else manage your money. You also have more control over what you own when you pick and choose individual stocks. You can do more in-depth research and decide on the right time to get into the market for you and your needs. Finally, individual stocks can be a great way to manage your taxes since you can decide when to take a loss or gain and when to buy and sell.
Suppose you’re new to the markets or looking to diversify. In that case, ETFs and Money Markets or mutual funds are pretty good places to stash your cash, and they offer a breadth of portfolio diversity that makes them relatively solid areas. Remember, you can still make sound financial decisions by choosing individual stocks, too. Know what your priorities are and your financial limits, and you are sure to make a sound financial decision.
“I Did It This Way, So It Will Work for You” Is Risky Advice
Everyone who has earned a bit of cash through diversifying, who has successfully saved for and then bought their first house, or who has even made some money in their 401(k) tends to immediately think of themselves as extremely savvy. The truth is that one success (while it can be an incredible stroke of luck and achievement) does not make a successful long-term strategy. What most people fail to realize is that times change.
Just look at the current state of housing in the U.S. as an example. Fifty years ago, you could purchase a home for a song, and you planned to remain in it for most of your life. Enter the current era with its housing boom and bust and the economic collapse of 2008, as well as new financial tools, and we have an entirely different housing market.
The pandemic has altered the housing market even more owing to unbelievably low mortgage rates. That means more people are trying to buy, which is great if you are already in a home and trying to sell. That also means you are likely to get the asking price or above for your home. If, however, you are a renter and don’t have the cash to put down, you’re largely locked out of the market because, as the Washington Post reports, the wealthy are snapping up real estate to take advantage of the low rates, while renters are being evicted so that landlords can get in on the major housing rush. Add to this the fact that we are currently in a serious housing shortage, according to Freddie Mac, and there’s a perfect storm of supply meeting demand and prices rising steeply as more people try to buy in a rising market.
The old adage that your home is the best place for your cash still holds water in some ways today, but the reality is that there are many, many people who simply will not be able to purchase a home in today’s environment. Therefore, this advice doesn’t work for everyone. Whenever considering advice from a loved one, mentor, or friend, remember that they have different needs, requirements, budgets, and ultimately access to things you may not. That can significantly impact how you diversify and whether their advice is worthwhile.
“Stick to the Status Quo to Make Money” Is Bad Advice
How many entrepreneurs who stuck to the status quo can you name? How many successful business leaders always colored inside the lines and became successful?
While some basic tenets underlie all good, sound, financial advice, the idea that you have to walk the same path as those before you is flawed. We wouldn’t have companies like Facebook or Google if everyone always followed the same path toward building a successful business, and the idea that there is just one way to do so is plain wrong. Being innovative and creative and following your gut instinct when it comes to choosing your work is the best way to ensure that you’ll make good money at what you do. Don’t let anyone tell you differently.
While there are plenty of platitudes about how best to manage your finances, many of them are just plain wrong. Sure, some basic, underlying fundamentals are essential to consider — but realize that a lot of the pop-psychology financial advice you see on the morning news or read on a blog is largely watered down and likely flawed. If you do the hard work yourself and set a budget that you can follow, you’re better off sticking to your own instincts about the right way to diversify, save, and spend your money. The more you understand about flawed advice, the better prepared you’ll be to build a secure and stable nest egg in the future.