How does something morph into the category of personal finance myths? It’s usually a combination of factors. First, the idea has to be believable. You could repeat the phrase, carrots are hazardous to your health 100 times but it won’t become a myth because no one will believe that carrots are hazardous to your health.
Second, the idea has to be repeated by many experts. Here’s an actual case in point. One scientist released a study linking vaccinations with autism. Expert after expert cited this study and a whole legion of anti-vaxxers sprung up. However, this scientist has now admitted he made up the entire study. It turned out to be not a fact but a myth because none of the scientists that quoted this study ever attempted to replicate it — they just repeated what they had read.
There are also personal finance myths or ideas that just won’t die because they’ve been repeated by experts over and over. Here are seven of the most prevalent of them.
When you retire you need to plan on spending 4% of your nest egg each year
This is actually more of a guideline than a rule but is one of the personal finance myths. You might actually be in a position where you could spend more. That’s the good news. The bad news is that in today’s economy, with its incredibly low interest rates and a very pricey market, it may be optimistic to plan on spending 4%. A better guideline might be 3% to 3.5%. And finally, the problem with this “rule” is that it doesn’t factor in the likely 20% tax bite.
You need to have an emergency reserve of three to six months of your living expenses
This one is so pervasive and makes so much sense we’ve actually cited it ourselves. But the fact is that in today’s economy people are often required to dip into their emergency reserves between jobs. It takes so much more time today to find a job that some people actually quit looking. But if yours is a dual-income household, your emergency reserve should be at least six months of your living expenses. Also, keep in mind that the more money you make the longer it will take you to find a new job. If you’re in a senior position it will just take you a lot more time to find a new job than when you were younger and you need to adjust your emergency savings reserve accordingly.
There is no cost to saving for retirement
Saving for retirement is always a good idea and the more you can save the better. However, despite what you might have read, there is a cost to saving. It is the invisible cost of what you miss out on while you’re sticking money away. As an example of this, if you put $3000 in your 401(k) instead of going on a great vacation, that $3000 will grow over the years but at the opportunity cost of a great vacation.
Many experts criticize credit cards because of the negative effect they can have, which is why it’s become one of the most often cited personal finance myths. Of course, it you misuse credit cards it can be financially devastating but this doesn’t mean you should necessarily avoid them entirely. Credit cards can actually be a great financial tool when used correctly. Your credit score is an important indicator of how reliable you are financially. If you have no credit cards it can be tough to establish good credit in order to get a mortgage, a car loan or other collateralized debt. In addition, if you have one or more credit cards and use them sensibly, you will have a high credit score which usually translates into lower interest rates and the ability to borrow more money. For many people, credit cards offer numerous financial opportunities and rewards so long as they pay off their balances at the end of every month.
It’s too late – I won’t be able to reach my financial goals
The fact is it’s never too late to start saving seriously for retirement. Of course, if you start saving at age 50 you certainly won’t be able to retire at age 55. But there are steps you can take to positively impact your goals. For example, if you are starting to save late, just increase the amount you save each month. You should also take a hard look at reducing your debts. As an example of this, you might downsize your house, pay off any personal loans or keep driving that car where you’ve paid off the loan instead of buying a new one.
If you’re getting started saving for retirement here’s a brief video with personal finances expert Dave Ramsey and how much he believes people should save out of their take-home pay to have a decent retirement.
It’s better to buy a home then to rent
The cold, hard truth here is that it can cost more to own a home than to rent. Homes always need maintenance and some of it can be very expensive. Just ask anyone that has had to replace a roof or have their home painted. Plus, there is no guarantee that a home will increase in value and they are highly illiquid. While the market where we live is very hot and homes tend to sell in a matter of days this is not true throughout the country. For example, in the state of Virginia it takes an average of 45 to 60 days to sell a house.
Your life insurance should be 10 times your income
This myth that you need to have 10 times your income in life insurance is very widespread. Unfortunately, like many personal-finance rules of thumb it’s inappropriate for most of us as it often leads to bad decision-making. The amount of life insurance you buy should be driven by a number of factors such as how many children you have, how likely it is that your spouse will suffer long-term employment and what this would mean financially. In addition, you should factor in your debts and your family’s long-term goals. If you do this, you might find buying 10 times your income in life insurance is either not enough or too much.