Christy Bieber* says if you rely on myths to make important choices about your money, you could end up in a very bad situation.
Photo: malerapaso
When it comes to money, there’s a lot of advice out there that’s repeated over and over.
While some of it is great, there are also situations where the conventional wisdom is wrong.
Unfortunately, if you rely on myths to make important choices about your money, you could end up in a very bad situation.
It’s important to research financial decisions carefully and to question the status quo to make sure you do what’s best for you.
In particular, there are four pieces of common financial advice you likely don’t want to rely on because they’re probably wrong.
- Save 10 per cent of your income for retirement
You’ve probably heard many times that you should save 10 per cent of your income for retirement.
Sadly, you’ll discover this is likely to leave you with far too little income to sustain your lifestyle after leaving work.
Saving 10 per cent of income simply isn’t enough to provide the funds you need as a senior.
To make sure you’ve got sufficient savings, it’s best to aim to save at least 15 per cent of income for retirement, but more is always better.
- The 4 per cent rule means you won’t run out of money
Conventional wisdom also says you’re safe to withdraw 4 per cent of your income from retirement savings during your first year and then increase withdrawals based on inflation each year.
But research from Morningstar Investment Management conducted in 2013 found that with bond yields below historical averages, the 4 per cent rule only provides a 50 per cent probability of success.
In other words, it’s 50–50 whether you’ll run out of cash if you follow it.
To have a 90 per cent chance of not running out of money, you’d need to follow a 2.8 per cent rule instead.
- Buying a house increases your net worth
Owning a home has long been a part of the Australian dream.
After all, if you own a home, you can build equity, benefit from increases in property values, and stop wasting money on rent.
It’s a sure path to riches — right?
If you’re still buying into this myth, ask anyone who bought their home at the height of the real estate bubble how that worked out for them.
Buying a home can make sense, if you’re financially ready for it, and if you don’t buy in a bubble.
But if you buy at the top of the market or if you purchase a home you can’t really afford and end up compromising other financial goals, you’ll be much worse off for it.
Timing the real estate market can be a challenge, but there are metrics you can look at — such as pricing trends in your area, months of new supply, and home prices relative to wages — to get an idea of how the market is doing.
You also need to make sure you have a down payment and an emergency fund before your purchase and that your housing costs don’t exceed 30 per cent of your income.
Unless all these things are true, renting likely makes more sense for you rather than becoming a homeowner.
- Paying down debt should always be a priority
Debt freedom is touted as a top financial goal by many financial commentators, some of whom argue you should never borrow.
And, indeed, there are times when you should work hard on paying off debt — like when you owe money on credit cards, payday loans, or high-interest personal loans.
But it doesn’t make sense to pay off all types of debt early.
Mortgages and student loans, for example, typically have very low interest rates.
If you pay off a mortgage at 4 per cent interest, your return on investment is 4 per cent at best — or less if you’re forgoing a tax break you’d have otherwise claimed to defray interest costs.
If you could reasonably expect to earn 7 per cent or more in the market, it makes no sense to forgo higher returns and put extra cash toward paying down your home instead of investing.
To decide if you really should focus on debt pay-down, always consider opportunity cost.
Don’t give up the chance to get more value from your money just because you’ve heard how great it is to be debt-free.
Don’t just follow financial advice
As you can see, if you followed these four common pieces of financial advice, you could end up in a really bad situation with a house you can’t afford, too little retirement income, and money allocated the wrong way that doesn’t maximise returns.
Instead of buying into the conventional wisdom, take the time to think about your own financial situation to make sure you’re really making the right choice for you.
* Christy Bieber is a personal finance writer.
This article first appeared at au.finance.yahoo.com.
