Ask anyone what the important rules of money are, and likely they’ll be able to give you several maxims that at least sound like they are good advice. Unfortunately, many people are walking around following rules that really don’t apply anymore — if they ever did. The subject of personal finance seems to attract old wives’ tales that masquerade as solid advice. If you follow any of these “rules”, you may be cheating yourself out of a fatter wallet:
1. Don’t use credit if you have the cash. This well-meaning advice assumes that you are not able to handle the purchasing power of a credit card. But when you have the cash is actually the perfect time to use credit. Your credit card can offer you any number of perks, and by charging when you have the money to pay off the card each month, you are earning those perks for free — not to mention the benefit of improving your credit rating.
This advice is especially troubling when you realize the flip side of the rule would be to use credit when you don’t have the cash. In that case, you would spend money you don’t have and also accrue interest. This rule should be rewritten to say “only use credit if you have the cash and a plan for paying it off.”
2. Make sure you get a big tax return each spring. For years, I believed that a friend’s philosophy of making sure Uncle Sam took as big a bite as possible out of each paycheck to avoid possibly underpaying taxes and to ensure a huge tax return was a sound idea. According to my friend, it reduced the tax headache and made for some nice “found” money each year.
Unfortunately, my friend is losing out by letting the government take what is — in effect — an interest-free loan of HIS money. Instead of letting the government use your money, use it for yourself! Figure out the difference between what you owe and how much has traditionally been taken from your paychecks and invest it. You’ll earn interest on that money and have much more to show for it than just a refund check.
David’s Note: The reverse is also a money rule that doesn’t always apply in every situation. Some people can save more if they get a lump sum, while others will save more if they get more from each paycheck. With the pittance in interests that you will earn if you got the money ahead of time, picking the right approach based on psychological benefits far outweigh deciding based on financial advantages.
3. Carry a balance on your credit card to build good credit. This rule comes from a long-standing misinterpretation of how credit works. In order to build credit, you must use credit. But that does not mean you need to carry a balance — and let interest accrue. Paying off your balance each month shows that you are a responsible consumer and will give you a great credit score. No balance necessary.
4. Your home is a great financial investment. We only need to look at the housing crisis to see that this one is not true. However, people still seem to think that they need to treat their home as an asset that they will eventually sell for a profit. Once you start viewing your residence as an investment rather than a home, poor decisions generally follow. This is what I often call the beige carpet effect. By treating your home as an investment, you never take the time to make it yours for fear of affecting the resale value. Remember, your home is where you live, first and foremost. If you make decisions about your home based on investment strategy, you’ll never feel like you’re at home and you’ll likely be disappointed by your house’s selling price, too. Buy a house you love and let the resale chips fall where they may.
5. Spend money to make money. People can use this “rule” to excuse anything from a risky investment to a new business start-up to gambling. But unless you can afford to lose the money you are spending, this rule is a recipe for disaster. You can make money in many different ways without having to lay out a dime — starting with working to earn more. So unless the cash you are spending is money you have to spare, spending money to make money is likely to bite you. Don’t use this rule as an excuse for poor decisions.