Dangers of the Water Cooler Talk
In personal finance there can be advice given or received that is contrary to facts, is false, or is misleading. At work you may meet a co-worker at the water cooler and discuss some of these topics. A few common topics you might hear are:
Paying off the mortgage early is a good thing
It is best to pay off high interest rate credit cards first
Owning cheap index funds is the best way to invest
Receiving a large tax refund is a good thing
Paying off a mortgage early will surely reduce the total amount of interest you pay to the bank and result in no mortgage payments at an early date. A more detailed calculation is required however to see if this will actually help you. Factors included would be your current interest rate, the rate you could earn on a conservative mutual fund portfolio if you invested instead, your effective tax rate, and the time until you retire to name a few. MorrowMoney.com has designed a complex spreadsheet that can take into account these factors and help you make the right decision with respect to paying off a mortgage early. The wrong decision could cost you anywhere from $100-$500k or more.
Popular opinion says that you should pay off your high interest debt first, which sometimes can be the best way to go. Much more important is to pay off smaller debts first because it results more cash flow available to pay down the bigger balances. MorrowMoney.com has also designed a formula to determine which debts should be paid off first. If one of your high interest rate cards is also a high balance, it could take years to pay off. You will have better results by paying off smaller debts first. For example, would it be more effective to immediately make $300 payments towards a large, high interest debt, or wait a year and make payments of $900 a month towards the same debt? It’s usually going to be the latter. The math can be complex, but a good adviser should be able to simplify it for you.
Most people believe that owning mutual funds with the lowest expenses ratios is the best way to go, but what is the cost relative to the value? Those who have read my previous blogs know that I do not believe in index funds because you are guaranteed to lose exactly what the index loses in a downmarket. The best mutual fund managers are paid as such, so their expenses are typically a little higher. That being said, you can still find excellent no-load funds with expenses ratios below 1.25%. Settling on an index fund is settling for mediocracy, which is a word that does not exist in my vocabulary.
Tax time is here and most consumers look forward to a large tax refund, but they could be hurting themselves. It is not uncommon to see a family receiving an $8,000 refund, but they don’t have enough money to cover their monthly expenses. This often leads to credit card debt and makes it difficult if not impossible to save. The large refund is only an interest free loan to the government. A W-4 shift will allow you to reduce your tax withholding and place more money in your wallet each paycheck. Consult your tax adviser on how to execute this change.
The bottom line is to be very careful who you listen to regarding personal finance matters. No matter what you hear, including here, the advice might not be right for you. Everybody has a different situation, and you should consult your CERTIFIED FINANCIAL PLANNER regarding any outside advice you receive.
Marc J. Morrow, CFP®