Unconventional Wisdom In Personal Finance

Unconventional Wisdom In Personal Finance

Not all advice is good advice...

What is often repeated is not always true. Especially in personal finance. Not every debt is bad, not every method of savings is good.

Let’s take a closer look at some widely accepted nuggets of personal finance wisdom, which may not be necessarily good for you.

‘Max out your 401K’

If I had a dollar for every time someone mentioned this, I wouldn’t need a 401K! On the face of it this looks like sensible advice – max out your tax-deferred savings. But take a closer look at how a typical 401K is setup. You have a limited choice of mutual funds to pick from, the funds themselves have high expense ratios and some have sales loads and if you wanted to go all cash, you don’t have a choice. (I’m speaking from my experiences with 401Ks, past and present)

Why feed an industry that exists just because there is no regulation or poor regulation? A typical 401K is setup in such a manner that the fund company and the 401K provider wins no matter how the market does. Do I sound like Ron Paul? Here’s an example:

Say you wanted to put your money in an S&P 500 index fund in 2011. A fund company that is loved by 401K providers is Rydex. RYSYX from Rydex, is an index fund that tracks the S&P 500. In 2011, S&P returns were 2.09% including dividends. Not great but better than keeping that money in the bank.

If you invested your money in an index fund that tracked the S&P, your returns should be close to 2.09% less expenses in theory.

If you had invested $10,000 in RYSYX S&P 500 index fund, you would’ve made $9,946.19 from 2011 to 2012 – a loss, when you should’ve seen a gain

Yes, you would’ve lost money when you should’ve seen a gain! And that’s because, RYSYX has an incredibly high fee of 2.29% and a sales load of 1% on top of it. Compare that with another index fund that tracks the very same index, Vanguard’s VFINX which has an ER of 0.17% and no load. From an investor’s point of view, both are identical funds.

With Vanguard’s VFINX, another S&P 500 fund, your $10,000 investment would’ve grown to $10,082.56 from 2011 to 2012 – a gain of $82.56

Given a choice, which one would you pick? Obviously Vanguard.

Choice, that’s what a 401K curtails. RYSYX is very profitable for 401K providers.

401Ks are the sole reason companies like Rydex even have costly funds like RYSYX.

Unconventional wisdom
Max out your company’s contribution. No less, no more. If your company does a dollar to dollar match, that’s 100% return! Don’t say no to that. For savings beyond that, consider an IRA. The limit is a lot less – $5000 vs. $16,500. See if your spouse qualifies for Spousal IRA. If you do, you just doubled your IRA space! Once you’ve exhausted these options, and if you still have money left, reconsider your 401K again as a last resort.

“Buy a used car”

This is actually good advice, but thrown around loosely. Yes, you do lose money the minute you take your new car out of the dealership. A used car is a better option, but then not all used cars are the same. There is an ocean of difference between a 10 year old Sebring and a 10 year old Camry. A worn out car will cost you more in the long run on maintenance. And you can never tell which part is going to fail next or when.

Unconventional wisdom
Buy a used car, but one that is still under warranty. This way, if a major part fails, you are still covered. If that is still beyond your budget, pick a car from a maker that has a reputation for reliability. Keeps your insurance low and you might get a good price when you are ready to trade up.

“Choose a 15 year mortgage over 30 year mortgage”

Another piece of advice that is frequently thrown around is that if you can afford a 15 year mortgage, you should go for it instead of a 30 year mortgage. Yes being debt-free sooner is good and with a 15 year mortgage you definitely lower your overall payments on your house… provided there is no disruption to your cash flow for the next 15 years! What if you lose your job and end up on a jobless spell for a year? You still have to make those payments and If you don’t have enough savings, you are toast.

if your emergency funds are limited and if you are like millions of Americans with a regular job, you should consider a 30 year mortgage even if you can afford a 15 year mortgage based on your current income levels. Use the extra savings to build up sufficient savings and once you reach a comfort level, make extra payments on your 30 year mortgage to pay it off sooner.

Even $100 in extra payments on a 200K loan will shave off 5 years of a 30 year mortgage. By making extra payments, you can pay off your house in 15 years if you choose to, but have the flexibility of adjusting the extra payments if there is a temporary cash crunch. A 15 year mortgage doesn’t offer you that advantage.

Unconventional wisdom
Sign up for a 30 year mortgage, but strive to pay it off in 15.

“Don’t raid your retirement funds to pay for your house”

Depending upon the type of the fund, there are different rules. With a 401K, you can take out a loan of up to 50% or $50,000 whichever is less tax-free and without penalties. With an IRA, you can use up to $10,000 penalty-free for buying your first home. Unlike a 401K, you don’t have to pay it back since this is not a loan.

Now, there are times when raiding your retirement can actually be beneficial. Say you are short of $10,000 on your downpayment to avoid a PMI. PMIs are monthly payments that you make as insurance premium for your lender in case you default. Read that again, this is not insurance for you, but your lender! From your perspective you are literally throwing your money away. This is one good example of using your retirement money to avoid PMI and use that savings to replenish your retirement funds, at your pace.

Unconventional wisdom
If using your funds means avoiding PMI, go for it, but pay it back with the savings.

“Avoid credit cards”

A more appropriate advice would be ‘avoid keeping a balance on your credit cards’. Whether you like it or not, credit cards have become a necessity today. All businesses factor in the cost of doing business using credit cards into their products and services. If you have the discipline to pay off your balance every month, why not get back your share of the costs? Choose a rewards card that works for you and enjoy the benefits while boosting your credit scores while you are at it!

Unconventional wisdom
Don’t maintain a card balance and enjoy the rewards of a good rewards card.

The takeaway

When it comes to personal finance, what works for your friend may not necessarily work for you. The best way to find out if a piece of advice is in your best interest is to educate yourself. The more aware you are, the better your chances of making the right call.

A fool and his money are soon parted.

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53 thoughts on “Unconventional Wisdom In Personal Finance

  1. I do many, but not all of those things. I max out my 403B, IRA nad Roth IRA. I refinanced my 30 year mortgage about 8-9 years ago tto a 15 year mortgage. I never bought a used car though, but I do keep my cars (17 & 15 years old)forever. I still use credit cards, but always pay off the balance every month. I have never done the other things! Does this make me unconventional? I would guess, yes.

  2. I agree with all of them. There is always some thinking involved. Some 401(k)s are very well structured – others are not. Many providers see themselves as monopolies once they are appointed because they know that people will automatically participate.
    There used to be one framed along the lines of “…you can’t lose in real estate”. Haven’t heard that one in a while!

  3. Great Post MC, I am the type who follows your unconventional wisdom. Got a standard mortgage of 25 yers but I dum the maximum lump sum payments allowed every year. CC wise, I regularly use 1 card but I never have a balance on it when the bill is due.

    The fees on RYSYS are painful, I can’t believe they can still get away with it!

  4. Good post, I like the way you succinctly made the case for going against advice that some strongly advocate. The 2 that caught my eye most were:

    1) 15 yr vs 30 yr. Agreed that we want our debt paid down and eliminated quickly. That said, some people have limited emergency funds and don’t need to cut things too close. Just because someone has a 30 year loan doesn’t mean that they can’t strive for paying it off earlier. It’s effecively insurance that one is paying, by opting for a lower payment and higher rate/loan length. But, it can be a good choice for some. I agree.

    2) Avoiding Credit Cards. I agree that credit cards aren’t inherently evil things that need to be avoided. If one has discipline, and pays them off in full each month, it’s a good tool to have at one’s disposal, and can be used to help build a good credit history. Plus, it makes tracking expenses a lot easier – at least for me.

  5. My 401(k) just moved to Fidelity Brokerage link.
    I can buy anything I want and that’s the way I like it!

    Avoid credit card. This works for me. I always pay off the balance every month, but I spend more if I use the credit card. Cash is harder to part with for me personally. :)

  6. I don’t follow half of them ;-)
    - I bought a brand new car because I wanted to have a nice car for the next 10 years (I’m at year 3 and I still LOVE my car!)

    - I’ve withdrawn from my retirement plan to buy my house and I certainly don’t regret it. It allowed me to buy my house faster instead of seeing its price skyrocketing while I wait to have enough savings.

    - I put every single expenses on my credit card… over the past 4 years, I’ve paid interest on it only once. This year, I’m taking my family (wife + 3 kids) to Disney World with my points ;-D

    great post ;-)

    • I have a friend who has an awesome gaming rig, very cool and very expensive. But here’s the thing: I would never advice him that he spent too much on it because that is his passion. He is in fact very frugal otherwise!

      The same goes for some one who is an avid sports fan and loves his monday night footballs. I wouldn’t advice him to get rid of cable.

      Be happy, not miserable!

  7. What if the company doesn’t math your 401K contribution? We put aside what we can, but we are unable to max it out. We need to pay down debt and build some cash reserves.
    As far a used car goes, that is exactly what we did: we got a used car that still was under warranty.

  8. I agree on everything, except for the car advice. We always buy a new car because my husband does most of our car work & he doesn’t like inheriting the results of a previous owner’s bad habits. He takes very good care of our vehicles & is almost religious about it. He wants to be 100% certain of how the vehicle was maintained. Most people don’t have the time or inclination for that.

    • If you are passionate about something, go for it! You are exactly right, most people don’t have the time or inclination to learn about their vehicles!

      But if you love doing what you do, enjoy it!

  9. I used to spew the “Avoid Credit Cards” mantra, too! I’m starting to realize (in the same way you describe) that credit cards aren’t evil…paying interest a the balance is.

    After years of avoiding them (because of typical, stupid mistakes), I have successfully used a low limit card over the last year & just applied for a new rewards card.

    What’s more important, in my opinion, is your (or my) ability to avoid temptation & using it to pay for stuff I don’t really need.

    I think I finally have it figured out…this time.

    • Not having the inclination to not use a credit card is good. Shows strength of character and discipline, but when you consider how the cost of doing a transaction is already factored into the products you use whether you pay using cash or card, it just makes sense to get back what is rightly yours!

  10. Mc,

    The problem i see a lot with maxing 401ks is that people put all or most of their savings there. You want balance you need short term money, taxable savings and investments. I have 2/3 taxable 1/3 retirement.

    Also retirement plans have a cash option its just not called cash. Look for the words ‘stable value’ or ‘money market’. Be careful here some of these funds also have high expenses.

    • On keeping cash, it depends upon your provider. My previous provider did not have even an option for treasuries!

      My current one has, but there are fees. This is exactly why I prefer IRAs. I get to choose how I invest.

  11. This is a great post. I have subscribed to many of these beliefs. My husband and I both max out our 401k to reduce our tax burden. I actually never thought of doing any different, I just really wanted to tax break.

    I also switched to a 15 year mortgage from a 30 when I refianced once because the difference in payments was minimal, and I do think that was a good decision for US. However, the economy was better back then too.

    I do love my credit card rewards. Earned 1500 last year! (although that also indicates how much I spent, although quite a bit was work expenses for my husband.)

  12. Very solid advice. I think that every ounce of wisdom needs to be taken with a grain of salt. Everyone’s situation is different, and advice for one person may not work for another.

    However, the bottom line is people have to plan and save for the future. I know that in my field of work, I have the option of a 457 (I think that’s what it is) on top of a 403(b). My goal is to invest in both within the next 18 months. The 457 allows me to max it out somewhere around $16,000 which is a great option. Research your options is all I can say!

  13. I do a lot of this as well. Max out 401K and get full company match. No credit cards. Always buy used cars (3 yrs off lastest model year) as I find that to be the best value.

  14. You are right about 401(k). I think you can manage Roth part of 401(k) on your own. Also, I always move money from 401(k) to self managed IRA once I leave a company.

  15. We do a lot of these things too. I like your idea about buying a used car still under warranty. That makes a lot of sense. I will definitely keep this in mind if we need to buy a new car.

  16. Buying a house with a 30 year mortgage and paying it off in 15 is an excellent way to get ahead financially. Even if you can’t make it by the 15 year mark,think of what you might save in interest if you were able to pay it off in 18 years, or even 20. Great article – thanks!

  17. I enjoyed this post although it conflicts me. I definitely don’t espouse 1 size fits all in every single situation, but I do guide my decisions based off of certain principles. That’s what I advocate, but I certainly appreciate where you are going. It’s brings up very interesting contradictions in advice versus reality. Another great post!

    • Thanks for your honest thoughts Roshawn. Of course, there is no one-size solution that will fit all. Evaluate your financial needs and act accordingly. But having a broad awareness on what’s out there will definitely make the decision making process easier.

  18. Very good ideas. I was contributing too much in my 401 (k). In January I did a reduction and now saving only 5% to get 100% company match.

    If we keep aside the PMI point, taking out loan from retirement account is not a good advice in general to me.

    • Good for you SB! In general, taking out a loan against your retirement funds is not good. Do it only if you think you can put the money to better use. PMI was one example.

      Taking money out of your 401K to buy a Hummer isn’t very prudent!

  19. You had me at the title. Great article MC :)

  20. I like the advice about a used car under warranty. That’s the way mine was. I guess it technically wasn’t “new…” had 4k on it, but it was under warranty for a long time and has been totally worth the monthly payments.
    And thanks for sharing the math on the 15 vs. 30 year mortgage. Definitely something to think about in the next couple years.

  21. I do most of those and I love the mortgage idea. Have recently considered to ask my bank to change my mortgage from a 30 years mortgage to a 15 or 20 years but after I read your post I might as well do extra payments instead and keep it at 30 years

    • Always evaluate your options Ella. It is very good you are thinking different and not just continuing to do what you always did with the 30 year mortgage.

      More information is more power!

      Thanks for visiting!

  22. Awesome advice. Are you trying to be the personal finance version of the Myth Busters? Nice job!

  23. I love my rewards credit card! I usually don’t keep a balance on it but I love using it to rack up points to get cash back. It feels great getting “free” money back and I use those funds to help my parents. -Sydney

  24. Awesome post! I agree with the entire content!

    It amazes me how so many people don’t evaluate their personal financial situation and follow advice that may not necessarily be good for them.

  25. People who like to perpetrate the 15/30 myth act like they can’t pay extra on their 30 year mortgage. If you are unsure about your finances, it makes sense to give yourself some breathing room on your mortgage, rather than locking yourself in to high payments.

  26. I’d challenge the buy a used car wisdom. I recently found that a used Toyota Camery costs as much as a new one! Buy new, and get all the perks that come with it (like a warranty).

  27. Very true that what works for some people won’t necessarily work for others. I tried to follow some of these unconventional wisdom tips in the past, and I wasn’t disciplined enough to do so. For me, a 15-year mortgage and no credit cards are musts; otherwise, I just spend too much!

  28. Excellent post MC! I especially like your ebuff of ‘don’t raid your retirement funds’. The Roth IRA is perfect for this. It’s a super efficient savings vehicle and we should never be penalized for withdrawing our own after-tax contributions. The incentives are in place to encourage us to leave it there, but once again the flexibility is convenient.

  29. What a great post, MC. Agree with going against the grain on the 401K strategy. Using 401K to buy hard assets which go increase in value is a good strategy, especially since the interest is paid to yourself.

  30. The 401k and IRA vehicles as a retirement plan concern me. Anytime the Gov’t is involved in ‘creating’ retirement planning, I grow weary. Consider these factors. 1. Company Match of 5% 2. Gov’t 10% Penalty if withdraw prior, to 59 (a fine of sorts) 3. Taxes are likely to be higher in the future 4. Value of the dollar lower in the future.

    If an emergency arises and funds are needed prior to 59, the 10% penalty erodes any company match. Put it like this, we put our money in ‘jail’ to take it out later when it is taxed higher and worth less.

    I’m not sold on investing in gov’t sponsored anything. I’m not anti-retirement planning, I simply don’t believe in replacing income with a fixed asset. Fixed assets are great for supplement but a poor income replacement strategy.

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