I've got some personal finance blasphemy to get off my chest. It will probably even ruffle the feathers of more than a few personal finance writers. I'll take that risk, because I hate to see money wasted. People are wasting money every day and not realizing it. They aren't even spending it, but these people are just giving it away for nothing in return.
How are people giving away this money? They ignore math to feel good about what they are doing. That doesn't make a lot of sense now, but after a couple of examples, my point will become more clear.
Paying back debt - Let's say you have 3 debts... a student loan for $5,000 at 5%, a car loan for $8,000 at 9% , and a credit card for $15,000 at 18%. Many people, notably personal finance "guru" Dave Ramsey, would say that you should pay off the student loan first as it's the lowest amount. The theory is that paying off that first loan will give you the psychology boost to stick with the program. Some basic math that I don't have the space to go into here shows that you will save more money by paying off the high interest credit card first.
Here's the fix: Don't consider each debt separately. Put them all in a spreadsheet (Excel, OpenOffice Calc, Google Spreadsheets), so that you can view how much you are paying off each month. I suggest you keep one side of the spreadsheet for how you are progressing by paying the highest interest and the other side for how you would be progressing if you went with the smallest debt first strategy. You'll be able to see savings you are making by being smart, which should give you psychological boost each month - not just when you pay off on of the debt.
Not convinced? Here's another example:
Paying off your mortgage early - Many people decide to make an extra payment or two a year to pay off their mortgage early. Some are crazy enough to pay a fee to set up bimonthly payments (most banks allow you set automated payments for free) to pay it off early. I don't want to say that paying off your mortgage is universally a bad idea, but depending on your mortgage rate it might not be the best plan. Many people think they are doing themselves a favor by paying off their 6% mortgage - which may act like 5% if the taxes are deductible. That's fine, but many of these other people will tell you that by investing in the stock market they would make 8-10%. If you are one of these people, you probably fall into the majority of Americans - and you are losing 3-5% of a very significant amount of money compounding over a lot of time (typically 30 years). This math mistake can cost you hundreds of thousands of dollars.
There are usually two arguments for paying off the mortgage early even when the math doesn't seem be on your side.
- The first is that paying off your mortgage is a guaranteed savings of 6% (or whatever your mortgage is). My answer to that is over any 30 year timespan that you choose, equity markets (if properly diversified) have always done better. If you don't believe in the equity markets span over a long time, perhaps your retirement plan should be based in real estate instead of 401K and Roth IRAs.
- The second argument is that having a mortgage forces you to save money. I can't argue this point, but it's hardly the only way to save money. I have my bank send a check to my mortgage company every month. It's just as easy for me to have my bank send a check to a mutual fund company. It only amounts to typing a different address in my online banking software. Like the mortgage, I only have to do this once and I'm set for 30 years. Google says I'm the 4th laziest man on the Internet and if I can do it, what's your excuse?
We all have psychological beliefs when it comes to money. Some might be addicted to their daily latte. Personal finance writers rail against it showing the savings one can have from eliminating this one cost. I suggest that convenient psychology excuses are many, many people's daily lattes. People, these are things that can and should be changed.
I know that other bloggers will say that personal finances are just that, personal. All that means is that they applies to you. It shouldn't give you a license to ignore math and take the easy way out. If you are on reading this site, or any personal finance site, I imagine that you are looking to change, learn, and grow. This is another way to do that.Â Why not step up the challenge?
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