Published in: Banks | April 16, 2020
3 Outdated Pieces of Financial Wisdom
By: Lyle Daly
Employing common financial wisdom isn't always wise.
Sometimes it's easy to separate good money advice from bad. Save some of your income? That's obviously smart. A friend saying there's nothing wrong with maxing out your credit card for a vacation? It doesn't take a finance expert to put that one in the "bad advice" column.
On the other hand, it gets difficult with tips that have been around forever and sound smarter than they are. They make sense at a glance. Other people swear by them, and you hear them all the time. While these pieces of financial wisdom may have made sense in the past, you can't necessarily rely on them anymore.
1. Renting is just throwing money away
You've undoubtedly run into this one before -- it gets thrown around all the time: If you pay rent, you have nothing to show for it. Some say you're just paying your landlord's mortgage. But if you buy a home, that money goes towards an asset.
This idea massively oversimplifies buying versus renting. It makes you think your options are paying $1,000 in rent or paying $1,000 for a mortgage and turning it into equity.
Here are a few things this advice fails to consider:
- Buying a home requires much more money up front than renting. You typically need at least a 3% down payment, and you need 20% to avoid paying extra for private mortgage insurance (PMI). Not so easy if you live in a place with high housing costs.
- In addition to a down payment, closing costs can be several thousand dollars.
- There are many more expenses for homeowners than for renters, including property taxes, mortgage interest, repairs, and, in some cases, homeowners' association (HOA) fees.
- If you need to move in the future, selling a home is much harder than leaving a rental.
You're not always throwing money away when you rent. Sometimes you're just paying for a place to live without the additional cost and commitment of buying a home.
2. Never use credit cards
There are several strong arguments against using credit cards. They encourage you to spend money you don't have. They have high interest rates. And once you're in credit card debt, it can be extremely difficult to get out of it. But the solution isn't to swear off credit cards entirely and only use cash or a debit card.
A better approach? Learn how to use credit cards to your advantage.
Despite their flaws, credit cards offer several advantages over every other payment method. You can often earn purchase rewards, which means you get something of value back for the money you spend. Responsible credit card use helps you build your credit score. And even though most credit cards have high interest rates, you'll avoid interest charges completely if you pay off your full balance each month.
Paying by credit card also keeps you safer from fraud. A thief who steals your debit card information can drain money from your bank accounts. You can dispute fraudulent charges, but it could be days or weeks before you get your money back. If fraudulent charges show up on a credit card, you just file a dispute and you don't have to pay them.
3. Spend 30% or less of your income on housing
You don't want to overspend on housing, and since it's many people's biggest expense, cutting down on how much you spend in this area is a great goal. However, there are two big problems with this 30% rule.
The most obvious is that in certain areas, it just isn't realistic for everyone. If you live in an expensive area, you may not be able to find homes that only cost 30% of your income. This is especially true for young adults who aren't making much money yet.
The other issue is that everyone's lifestyle is different, so we can't all follow the same guideline on housing costs. There are always exceptions. You may want to pay more, for instance, if you can get a place within walking distance of your work. In that case, savings in commuting time and transportation costs may outweigh paying a premium for your home. Similarly, if you don't go out much, you won't be spending a lot on dining and entertainment. In that case, there's nothing wrong with putting extra money toward a home that you love.
Don't take financial wisdom at face value
The lesson here is simple: You should never blindly accept supposed financial wisdom, no matter how logical it seems at a glance. Dig deeper and do your own research to find out if you're really getting good advice or just an outdated cliche.
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