Ask anyone what the important rules of money are and they’ll likely be able to give you several maxims that at least sound like good advice. Unfortunately, many people are walking around following rules that really don’t apply anymore. 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 to pay for it. This well-meaning advice assumes that you aren’t able to handle the purchasing power of a credit card. After all, studies have shown that consumers spend roughly 30% more with a credit card versus those using strictly cash.
Still, it’s a different story when you already have the cash saved up for what you want to buy. 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.
My credit card, for example, offers 2.5% cash back for everything I buy. That’s an instant discount. Some even offer 5, 6% off for specific categories. The savings add up.
This advice is just 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, my friend made sure Uncle Sam took as big of a bite as possible out of each paycheck to avoid possibly underpaying taxes and to ensure a huge tax return. He just thought it 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 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 using credit doesn’t mean you need to carry a balance and make interest payments. Paying off your balance each month shows that you are a responsible consumer and it will give you a great credit score.
In fact, a credit card that you never use and the mere history of owning it will still help build your credit. Having no balance whatsoever is perfectly fine.
4. Your home is a great financial investment. We only need to look at each housing crisis to see that this one is not true. However, housing could still be a bad investment even in good times.
There’s no question that house prices have gone parabolic in the last few years. In fact, there isn’t a week that goes by these days when my neighbors aren’t talking about how much our homes have been appreciated. Sure, it’s a great feeling when it seems like you own an asset that’s valuable, but it’s not like you can readily access that equity. You can sell the house, but where are you going to move to? Unless you have more than one property, you still have to live somewhere.
Plus, you could have made just as much, if not more, if you put that down payment into the stock market during the last couple of years. This is especially true after you factor in the maintenance cost of the place. The money in your house worked out just fine, yes, but not as much as anyone thinks.
Also, poor decisions generally follow once you start viewing your residence as an investment rather than a home. 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.
Money rules are great because they are easy to remember so they help nudge us to be better with our finances. But really make sure you understand them or else you may be applying them incorrectly.
What money rules do you think people misinterpret to the detriment of their finances?
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GREAT list!
I’m glad to see someone else point out that credit cards are not the Devil, but a tool that when used properly (i.e. when you already have the cash) can enhance your financial situation.
As for taxes and mortgage payments… I wish I could charge those on my card too – think of the points I’d rack up! 😀
Perks for free?
There’s no such thing as a free lunch. Those perks don’t come for free. Everything is 3 – 6% more expensive than it needs to be because of all the transaction fees that credit card companies charge. So, everyone is paying more than they need to for everything. Furthermore, all the people that have credit cards that don’t have any perks are subsidizing the perks for those that do have perks credit cards.
Don’t get me wrong. We use our perks credit every chance we get, but I don’t fool myself into believing the perks are “free.”
Great post! I wholeheartedly agree with breaking these “rules.” I don’t think there is necessarily anything wrong with thinking your home is a great financial investment, although I do agree that you should also understand that you should live in it and treat it as a home.
I feel like 3 and 5 are kind of silly myths while 1 and 2 are more psychologically focused advice for people who may not have as strict a control over their spending habits.
Excellent article. I particularly love the #1. I have been using my credit card for everything and just paying it off at the end of the month. I have enough financial self control not to overspend every month.
As for #4 I think it is more practical advice. The way the market has been going the last 4 years it is hard for anybody to view it as a good investment but I do think the market is going to bounce back. It’s not going back to the days where your house gained 10% in value overnight but in 10 years, chances are you will probably sell your house for more than you paid for it today.
I agree that going against conventional wisdom really helps, in particular on home ownership as an investment. The tax benefits from mortgage payment helps though, since the interest is tax deductible. Spend Monet to make money is an American classic, you never hear it elsewhere!
Great article. I think the most important is #1 or #5. Keeping the monthly debt low and learn to spend your money on what makes money. Awesome article!
As the old adage says ‘never bite off more than you can chew” or just don’t spend more that you make, and pay yourself first (and stash that money away before you spend anything!). That is the basis of all saving and spending.
Make and stay with the rules you make.
Saw this train wreck coming, and now i am in the mists of the wreakage.
Tried to be honest, and upgraded my 70 year home, and found
that everyone hands were in my wallet.
Thanks for mentioning these common “rules.” I’m a big fan of using my credit card to pay for everything; even for small purchases. I guess the only reason why someone wouldn’t want to use a credit card is if they don’t have the discipline to pay it on time or in full every month, even if they have the cash.
Regarding homes, like you said, people should treat it as a home. A roof over their head, and nothing else. When selling a home, people always forget to calculate how much in interest they’ve paid as a result of having a mortgage. They need to remember that in order to profit from selling a home as an “investment,” they need to sell for more than their original purchase price, property taxes, insurance costs, interest expenses, improvements, and maintenance costs all combined.
I disagree Long. My property taxes, insurance, repairs and minimum mortgage payment are equivalent to the amount I would pay to rent a comparable place. Therefore when looking at my profit, I would not include those because I have to live somewhere.
I see your point, but when you’re looking at it that way it’s not really a “profit.” You may be selling your home for more than what your purchase price was, but in terms of an investment – there probably was little or no gain when you factor in all of the expenses.
My comment was really just based on a position of treating a home as purely an investment. When treating it as a place to live, like everyone should, the opportunity cost of living elsewhere should definitely be taken into account like you mentioned.
I can see both sides of the argument as being valid. Like Ginger said you have to live somewhere and living costs can be equated to rent more or less. In the end, it just comes down to which one suits your needs better.
-Jean
I believe Ginger and Bob are talking about two different things.
Bob is talking about an investment property (obv) but I’m unsure as to if Ginger is, as she is speaking about living there. It would not be an investment property in the latter case. If you live there so it would not be classified as an investment.
Bob is correct in saying you would need to manage all of your expenses to understand if you are actually making a profit on your income property as that is the main goal.
Good advice that only applies if you can manage your finances. To have a good house with a little loan is good for both your creditworthiness, credit opportunity and a long-term savings for the future.