We all carry around ideas and assumptions about “the right way” to manage money. Many of us were thought these “lessons” at an early age by a parent, a teacher or a mentor and we never really challenged the wisdom in these assumptions.
We live in a rapidly changing economy, as a result, many of our assumptions about how we should manage our finances are outdated. Here are four assumptions about personal finance that you should ignore.
Buy as much house as you can afford
There was a time when the consensus thinking around buying a home was that the smartest thing you could do is buy as much house as the bank will lend you.
There were two assumptions driving this thinking
1. House prices always go up
2. “You’ll grow into it”
If in 2006 someone told you to buy as big a house as you can afford because real estate values never drop, it would be difficult to argue with that person.
The assumption that real estate prices never drop was true for nearly every single year from the 1940’s onward. Prior to 2008 entire generations had grown up with the reality that real estate was a safe investment.
Through booms and busts in the stock market, U.S real estate just kept on chugging along, prices kept going up and up and up. Until they didn’t.
The subprime mortgage crisis in 2008–2009 reminded everyone that, yes, real estate prices can go down and if you have overextended yourself, so can you.
Another assumption people used to justify buying a bigger house than they need was that “they will grow into it”. If you’re single with no kids, go ahead and buy that 3-bedroom house with a giant backyard. “One day you’ll be married with kids, and you’ll be happy you have the extra space.”
People seem to have taken this advice and as a result, our houses are bigger than ever.
1. In 1973 the average house size was 1,660 square feet
2. in 2015 the average house size was 2,687 square feet
The problem? We never “grew into” our big houses. Our families have never been smaller.
- In 1973 the average household had 3.01 people living in it
- In 2015 the average household had 2.54 people living in it
We are spending more money on housing than we ever have because we are buying bigger houses than we need. Housing is the average family’s biggest expense, if you are struggling to save money perhaps you should start by evaluating how much house you need?
The old advice: “Buy as much house as you can afford”
The new advice: “Buy as little house as you are comfortable living in”
Pay off your mortgage as quickly as possible
Many “financial guru’s” (a term that also needs to die) like Dave Ramsey have long advised that you should pay off your mortgage as quickly as possible. In the 1980s when mortgages were pushing 19% this was good advice. At that time, a $100,000 mortgage would be like having $100,000 in credit card debt today.
Today, when mortgage rates are near all-time lows, why would we want to prioritize paying off our mortgage over investing?
For one thing, inflation will reduce the real value of your mortgage over time. A $100,000 mortgage in 20 years is a lot less money than a $100,000 mortgage today.
I recently ran the numbers to determine which option would help you build wealth faster; paying off your mortgage or investing. While the ultimate decision of whether you should invest or pay down the mortgage should be made of personal factors, here is a general rule of thumb.
- If your mortgage rate is locked in at less than 4%, the math would strongly favor investing.
- If your mortgage rate is higher than 4%, the math would begin to favor paying off the mortgage.
The old advice: “pay down your mortgage as soon as possible”
The new advice: “don’t blindly follow financial gurus. Make the best financial decision based on your personal circumstances and preferences”
Save 10% of your income for retirement
This was perfectly fine advice when everybody had a pension at work, and you could comfortably afford a house on a median salary.
If you don’t have a pension plan, you’re going to need to save a LOT more than 10% of your income if you ever hope to retire. Mr. Money Mustache worked out the direct relationship between your savings rate and when you can retire.
If you are only saving 10% of your income each year, you won’t be able to retire for 51 years. Meaning if you start saving at 25 and maintain a 10% savings rate, you’ll be working until you are 76.
If you want to avoid working into your 70’s or 80’s, you’ll need to embrace the concepts of the Financial Independence, Retire Early (FIRE) movement. It’s all about your savings rate. The more of your income you can save and invest, the sooner you will have
If you are 25 and you want to retire at 55, the above chart makes it clear that you will need to save 28% of your income for retirement.
The old advice: “save 10% of your income for retirement”
The new advice: “figure out when you want to retire and adjust your savings rate accordingly”
It’s rude to talk about money
The worst financial advice I’ve ever been given is that it’s rude to talk about money. As someone who spends much of his free time discussing money, I couldn’t disagree with this idea and stronger.
It’s rude to gloat about money. If you have $1 million in your bank account, you shouldn’t gloat about it Infront of your friends that are struggling to pay their bills. That makes you an a*s hole.
It’s necessary to have meaningful conversations about money and finances. There are two benefits of talking about money.
1. It will bring you closer to people
2. You and the other person might learn something
Money is a deeply emotional issue, so people’s natural inclination is to not talk about it. Our deepest fears and hopes, insecurities and goals are all wrapped up and intertwined with money. But once you get over the initial hurdle of discussing such a personal issue, you can really get to know someone.
Some of the most powerful conversations I’ve had with close friends is when we “get real” and honestly talk about money. It helps to know you are not the only one struggling with money problems.
When you talk about your money problems with people who care about you, they may also give you some fantastic ideas of how to fix them.
For married couples or people in committed relationships, it’s critical to talk about money.
Money is the number one source of tension and stress in relationships and one of the primary causes of divorce.
If you want to succeed financially and in marriage, you need to lay all your cards on the table.
The best advice I’ve heard about money and relationships is to 10 minute weekly “money meeting” with your significant other. During the meeting, you can discuss anything that is on your mind.
- What you spent your money on last week
- What big purchases you have coming up what money issues are causing you anxiety
- Getting on the same page about a debt repayment strategy
- Getting on the same page about an investment strategy
Just make sure you keep your money meetings short and frequent. If the meetings are too long, they will feel like a chore and you are likely to stop having them. If you don’t hold them frequently enough, it’s hard to turn it into a habit.
The old advice: “It’s rude to talk about money”
The new advice: “It’s necessary to talk about money”
What are some other outdated pieces of personal finance advice you can think of? Let me know in the comments.
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions