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Money Survey

Mistakes To Avoid


Ms. Morrison was interviewed and asked what the Worst Financial Advice that she had ever heard given was (this was NOT her advice).  Here are her responses to bad financial advice.

401(k)s

An old accountant advised we cash in a substantial 401 K plan to pay off credit card debt rather than institute a plan to pay it off over time and learn how to spend and save at the same time. **Two points here where the accountant’s advice totally missed the mark:

  1. 401(k)s are for retirement, NOT current debt repayment, and since no age is mentioned, I’ll presume the folks were under 59 ½, which means there would have been a 10% penalty in addition to the current income taxes owed on whatever amount was cashed in. (Even if folks were over 59 ½ years old and no penalty was exacted, paying tax on monies that otherwise are accruing tax-deferred until retirement is taking monies from a “tax-protected” fund for current expenses = not good.) A LOAN on 401(k) monies could have been acceptable advice, insomuch as a loan through a 401(k) is established and a rigid, monthly repayment schedule requires the participant to pay off the loan, thereby maintaining the retirement funds for their original intended use.
  2. Credit card debt happens for a host of reasons, yet most often is as a result of not paying attention to mounting balances and extended months of living above one’s means. Granted there are extreme examples, whereby a person’s roof leaks and furnace malfunctions and car breaks down all in the same month, and an immediate infusion of cash is needed from credit cards; that’s different. In most cases however, one needs to consciously address the problem of mounting debt, and understand fully the debilitating effects of a poor FICO score, so absent some “learning” of how one got into the mess they’re in, one will likely get into it again. Eliminating the amount of indebtedness once (with whatever source of funds) without correcting the core problem is about as ineffective as removing all of the alcohol from the house of an alcoholic. Problem solved for a New York minute, yet surely more pain ahead.

Charge Cards

By far the worst financial advice I’ve ever gotten was during college when I was told to open a credit card and use it to charge all my books and school fees on. The 19% or more interest on a credit card is far more than the subsidized government loan that ended up covering my school costs. **While college aged kids generally are offered a ‘teaser’ rate of 0% interest or close to it, eventually the real rate emerges and it’s not pretty; i.e., 19%. While establishing credit is a worthy intention, one needs to pay off the balance in full each month in order to establish GOOD credit; otherwise, maintaining a balance over the months, while paying the minimum payment actually establishes a negative credit score. So, ensure that once you obtain your first credit card you can indeed pay off the balance in full each month. That scenario rarely exists in college. Plus college aged kids are still not fully cognizant of the value of money, nor do they remember what they charged yesterday, let alone last month, so the presence of a plastic, get out of a jam card in their wallet or hip pocket can be an enabler to overspending, at precisely the time that kids should be learning money responsibility. Yes, the subsidized government loans or grants are the best route for paying your college expenses. There’ll be plenty of time to obtain credit cards after graduation. Graduating with the loaned expenses of college is one thing, tacking on another $20,000 in credit card debt is often too crushing load to bear; resist this at all costs!

Mortgages

Paying off your mortgage as quickly as you can. Most people have more pressing financial priorities. There are more important financial goals that need to be accomplished with your money than paying off low-rate, tax-deductible debt. **Given that the interest on $1,000,000 of mortgages and an extra $100,000 of Home Equity Debt is still tax deductible on most taxpayers’ income tax returns, it remains a great write-off opportunity insomuch as one would multiply the interest paid on a mortgage by their income tax bracket, and that is the amount they saved due to the write off. So, if the mortgage rate is 5%, and one’s income tax bracket is 30%, they saved 1.5% interest; i.e., the true cost to the homeowner for that mortgage was a scant 3.5%. Where else can you get a roof over your head and all the benefits of homeownership for 3.5%? In other words, because of the income tax deduction, mortgage money is ‘cheap’ debt, and it gets ‘cheaper’ the higher your tax bracket. So, instead of paying EXTRA each month for example, re-route that extra cash flow into your long-term investment portfolio, thereby effectively using ‘cheap’ debt to your advantage. Debt in and of itself is neither good or bad; it’s all in how your manage it. The worst money advice I’ve ever gotten is to buy an extra house, get a tenant, and let the tenant’s rent pay the mortgage and all the bills. So many people and books say this. **Ah, passive real estate, right? Remembering that rental houses require MORE money for repairs since no one cares about their rental house as much as you do, is oft overlooked in the advice of buying rental property. The proper preparation for owning rental property is to assume:

  • that you will be turning over renters annually—incurring costs of painting, recarpeting, and repairing damage, and
  • that you will go vacant on average 3 months between renters, and
  • that your renters will consistently pay late without including the late fee such that your mortgage payment is late otherwise wrecking your FICO score, and
  • that you may have to spend a couple months’ rent to evict certain tenants.

 

If you are able to set aside in a “sinking fund” (every pun intended) the sum total of all these expenses–as well as the cost of a management fee, unless you enjoy being awakened at 4am with a call that the toilet’s leaking–then have at it. Otherwise, put your extra money that you would have used to buy the property into maximizing your 401(k) or 403(b) plan at work, and invest the excess into a truly passive mutual fund portfolio.

Listen to Debra’s Good Advice:

 

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