We see advice about what to do with our finances everywhere from well meaning family and friends to so called experts on social media. Although some advice is priceless, a lot of advice can put us years behind the 8-ball.
You need to know the principles of terrible financial advice as much as you need to know good ones. When people think about the best financial advice they ever got, they usually compare it with the worst financial advice they ever received, which, in many cases, makes for an even more valuable financial education.
The financial realm is strewn with misinformation, outdated advice and just plain bad advice — bad advice that has cost people their savings, retirement funds and financial well-being. Whether they’re simply following hot stock tips or letting emotions guide their investment decisions, poor financial advice can take many shapes and can plague investors of any level of income or education.
The Most Dangerous Financial Myths That Cost People Money
One of the most common pieces of bad financial advice is the idea that debt is bad and it should be avoided like the plague. That is true, consumer debt with a high interest rate ought to go, but this across the board call to eliminate all forms of debt ignores the potential strategic benefits of good debt. Many people forego opportunities to build wealth with real estate or business investments because they learned that all borrowing is evil.
Another fiscally destructive myth is that it’s always best to buy the biggest house you can afford. That advice has left innumerable families house-poor, meaning so much is spent on the mortgage that they are unable to save for an emergency, retirement or other financial goals. Part of the problem with the 2008 housing crisis was this attitude — people reaching above and beyond what they could actually afford, figuring real estate is always a great investment.
The “get rich quick” type of thinking is probably the most dangerous bad financial advice there is. Whether it’s these sorts of day trading operations, or crypto speculation, or multi-level marketing or whatever, all these schemes promise that it’s possible to get ahead on easy street. Those who take such advice end up losing a lot of money, conveniently ignoring boring but successful strategies that actually create long-term wealth. The juxtaposition becomes particularly apparent when you think about what the best financial advice you ever got was – it usually comes from patience, consistency, and an understanding of the tried-and-true, rather than flashy shortcuts.
There are now another type of bad advice, created by credit card rewards programs. Responsible users can reap rewards, but not everyone does, says ye olde common sense person, and a lot of people get the advice to “maximize rewards” without taking into account their established spending habits. This results in overspending to earn points, carrying balances to keep accounts open and opening more cards than necessary — and ultimately paying more in interest and fees than receiving back in rewards.
Examples of Poor Financial Advice That Seem Reasonable
Some of the most terrible financial advice sounds reasonable on the face of it, and so it’s particularly pernicious. “I only invest in what I know” is good advice in some ways, but it often means going into battle underfunded (i.e. delightfully diversified). Many people take this to mean investing all of their money into their employer’s stock or their home market, exposing them to dangerously high levels of concentration risk which could destroy their portfolio if that single area performs poorly.
Another piece of seemingly sensible but ultimately dangerous advice is that young people should not invest since they have little money. This advice ignores the magic of compound interest and time to build wealth. A 25-year-old who invests $100 a month may have far more money by retirement than someone who lets that same money compound for a decade longer, starting at age 35 with that investment amount. The opportunity cost, of taking this often-parroted advice can be measured in the hundreds of thousands of dollars over your lifetime.
Like with many sound but unsound financial advice (i.e. “pay off your mortgage early”), it’s just sound advice that can sound dumb. As psychologically satisfying as it may be to be free of debt, the math frequently argues for investing the extra payments in diversified portfolios, which have historically returned more than mortgage interest rates. Such advice takes a turn for the worse when people liquidate their emergency savings, or raid retirement accounts, to pay off mortgage debt.
But emergency-fund advice can get into trouble when taken to extremes. Need for emergency savings The necessity of emergency savings is a given, but the advice to keep three to six months’ worth of expenses in low-yield savings accounts may be overkill for stable workers with diversified sources of income. This overly defensive position could mean missing out on potential returns over the years, particularly in a low-rate environment where inflation chips away at purchasing power.
We also hear that some people are urged to eschew the stock market altogether simply because it’s deemed “too risky” or “like gambling.” This advice, he said, often comes from well-meaning people in older generations who have lived through market crashes, and it ignores the historical truth that the stock market, well diversified, is one of the few asset classes to outperform others over the long term. Heeding this advice usually leads to an underfunded retirement and a life of scarcity, not abundance, because traditional savings accounts and conservative investments cannot keep up with inflation and growing financial demands.
What Financial Advisors Don’t Want You to Know
The financial services industry has a tendency to act as if the world is still divided between buyers and sellers, and in some cases it persistently spouts advice that is more helpful to the sellers than the buyers. One well-established one is the urge to climb on the actively-managed mutual fund wagon, where the expense-ration charge can be high, while low-cost index funds tend to do better over time. Many advisors are compensated via commissions or other fees which can be higher on these pricey products, leading to conflicts of interest that can cost investors big dollars over time.
Insurance sales are often disguised as financial advice, which results in inappropriate recommendations for expensive whole life or universal life insurance policies, when most people would be better served by term life insurance. These complicated insurance products usually have a lousy investment return component but pay big commissions to the salespeople. The cost differential can add up to tens of thousands of dollars over a lifetime.
Some financial advisers discourage clients from educating themselves about investment, warning that planning is so baroque that it’s best left to professionals and experts. Professional advice has its place, but this mentality creates dependence and blinds clients to how to manage their money on their own. The best financial advice empowers you through education and knowledge, not blind delegation.
Fees is yet another aspect where advisors may play for their interest and not in the interest of the client. Advisors who are commission-based may have an incentive to churn or sell you an inappropriate product in order to generate commissions. And even some fee-based advisors sometimes suggest strategies that are more complicated and costly than they need to be, when a simple, low-cost strategy would work just as well or better for less money.
The time-bound nature of financial advice exposes yet another possible conflict. This may be in the form of market timing strategy recommendations or suggestions to wait for “better” conditions in the market, usually due to the adviser reacting to his or her emotions or trying to look savvy. But, as was often the case, time in the market usually trumps timing the market, and that bad advice can leave stock-pickers sitting on the sidelines as they miss out on opportunities and a chance to earn higher returns.
When people ask me what is the best piece of financial advice you ever got, they are usually looking for something that they may not have thought of that in a simple way can help them see their situation free from the noise inside their head — some simple, famous old principle that it’s easy to forget in the daily battle.Edward C. Johnson, III on What the Best Piece of Financial Advice You Ever Got?It usually (hopefully) benefits the long-term interest of the evolving investor as against the short-term interest of people trying to make a buck selling them a financial serviceEdwards Deming, John Bogle and a Bridge Game at the Cohan-VanHarnick House. Good advice tends to revolve around keeping costs low, being diversified and patient, moving with the market in an incremental manner minus the salesman’s fancy pitches.
Turning Bad Advice Into Learning Opportunities
Deconstructing bad financial advice provides — reveals the potential for better decisions and better outcomes. It is not about reasoning skills and learning why sound financial planning works well, rather than following any one’s random advise, no matter how well educated and/or attached to you.