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الخميس، 26 مايو 2016

9 Common Pieces of Financial Advice That I Consider Mostly Useless

I read a lot of personal finance books and personal finance articles. You’ll often find me at the library digging through the personal finance section, pulling out issues of Money or Kiplinger’s, or sitting at a table taking notes.

Unsurprisingly, I see a lot of the same advice trotted out again and again in publication after publication. Most of this advice is really good stuff. Spend less than you earn. Pay off your debts. Contribute to your retirement fund. It’s all sensible advice that will reward almost anyone that follows it.

However, time and time again, I see people putting out skewed advice. That advice isn’t bad per se, but it’s usually worse than other options and can lead to bad financial problems if it’s not perfectly followed, whereas the best financial advice is practically foolproof.

Why are these pieces of advice given out, then? For one, the author of the article or book often has an ulterior motive in giving that advice – self-promotion, for one. For another, they’re sometimes repeating advice that they’ve read and used elsewhere without thinking about whether it applies in these other situations. Add those two together and you end up seeing a lot of questionable nuggets of financial advice.

Here are nine pieces of dodgy financial advice that I often see shared. While these pieces of advice can be good, they’re often given in situations where they’re complete overkill or they don’t really make much sense at all.

Dodgy Piece of Advice #1: Hire a Financial Advisor

Let me be clear right off the bat: Financial advisors can be great and they can be incredibly helpful in certain situations. If you have a complex financial situation, such as dealing with a large or challenging inheritance, a financial advisor can help you piece through your situation and come up with a sensible plan. If you’re considering hiring one because you’re in a tough situation, here’s my detailed guide for finding the right financial help for you.

However, they are not a be-all-end-all solution for all financial questions. In the vast majority of situations, they don’t really provide anything you can’t do yourself for a lot less expense. People turn to financial advisors to answer questions that can be found in any personal finance book. They also turn to them for things as simple as investing their extra money, something you can do in five minutes from your personal computer at home.

They also sometimes provide a crutch for people to avoid learning about personal finance themselves. Many people just turn over all of the keys to their financial situation and their planning to their advisor without having any clear idea of what’s going on or what’s happening. That’s fine if you have a great financial advisor, but what happens when that advisor isn’t highly competent or, worse, has nefarious plans for your money?

Another problem comes in when you look at commission-based financial planners. Commission-based planners have a financial interest in guiding you toward investment options that provide a larger commission for them. Even the best and most honest advisors can be swayed unconsciously by the lure of commissions.

All in all, the best solution is to teach yourself about personal finance and handle routine financial situations, such as setting up a Roth IRA, on your own without any sort of financial professional help. Not only will this save you money, it will improve your own understanding of your financial choices.

Dodgy Piece of Advice #2: Invest in Things You Don’t Understand

This one might shock some people. After all, you’ll never, ever see a financial writer say anything directly like this. Yet, if you read closely, many financial writers are actually saying this indirectly and doing it over and over.

All you have to do is read articles on new investments or listings of mutual funds to see it. These articles trumpet these investments, practically guaranteeing big returns if you put your money in them, but never seem to actually talk about what the investment actually is, what the philosophy behind the mutual fund is, or who’s involved with it other than the name of the company. Yet, the conclusion is that you should be investing in these things.

That’s a foolish mistake. If someone is telling you about an investment and proclaiming that you should be invested in it but isn’t giving you enough information to really understand what it is you’re investing in or providing direct pointers to learn more, then you should run away from that advice. Never invest in something you don’t understand, and reading an article that briefly mentions an investment does not count as understanding that investment.

If you’re going to invest, do your homework. Don’t trust a one paragraph summary from any financial writer. Learn about what the investment is, and keep going until you really understand it to the point where you can explain it in one sentence and then handle follow-up questions, too.

Dodgy Piece of Advice #3: If You’re Not Invested in X, You’re Making a Big Mistake

I don’t see this too often, but I see it often enough that I can’t help but worry that people fall for these kinds of pressure tactics. Simply put, some authors like to make the case that the investment they’re talking about is such a perfect investment for everyone and can generate such amazing returns that literally everyone should invest in it, and thus anyone that does not is a fool making a giant mistake.

There are two root causes for this kind of nonsense. One, someone is really a true believer in this particular type of investment. They really believe that this is the best option for everyone. That person is usually just overenthusiastic and perhaps a bit misguided.

The other side of the coin is more nefarious. Salespeople who are overzealous in their promotion of a product like to use these kinds of pitches, like the people who promote penny stocks from highly troubled companies. They want you to buy in so that they can make money, whether it’s from pumping and dumping a stock or continuing to inflate a housing bubble.

The reality of the matter comes from almost every other piece of financial writing out there. Unless you are an extremely skilled investor who spends most of his or her time focusing on investments, the best strategy to use is diversification at a low cost. Putting all of your money – or even most of your money – into one particular investment is a bad move, because if that one market fails, you’re going to be in a bad place.

Dodgy Piece of Advice #4: Don’t Bother with Frugality – It Won’t Build Your Wealth

Few pieces of “advice” irritate me more than this one, because it is absolutely false. Over a five-year period, Sarah and I paid off a six-figure mortgage, two separate five-figure piles of student loans, three different car loans, and an untold amount of credit card debt. I attribute that change to frugality above all else. What happened at the end of all of that debt repayment? We had tons of money to invest each month. We currently live off of approximately 50% of our income, which means that we have literally tens of thousands of dollars to invest each year.

You can be the greatest investor in the world, but if you don’t have any capital to invest, you’re never going to be able to build wealth. If you’re living paycheck to paycheck, you’ll never have any money with which to invest. The only way to get money to invest from your life is to spend less than you earn, and frugality is one of the key tools to make that happen.

Usually, financial writers who want to make this point use some sort of weak example of frugality. They’ll find some really ineffective frugal tactic, like washing Ziploc bags, point out how doing that only saves a nickel, and then act as if that’s proof that frugality doesn’t work. What foolishness. For one, most frugal tactics are far more effective than washing Ziplocs. For another, most frugal tactics save money because they’re repeated frequently – if you do something that saves a dollar a day, that’s $365 after a year. That’s a car payment on a pretty nice car.

Take a look at Warren Buffett. He’s a billionaire dozens of times over, yet he lives in a modest home in Omaha. Why? Because he knows that the more money you spend on nonessential things in your life, the less money you have to invest. What’s frugality all about? It’s minimizing spending on nonessential things in your life, so you’ll have more money left over.

Anyone that tells you not to bother with frugality is never going to help you build wealth. To build wealth, you have to spend less than you earn, and frugality is how you keep your spending low. It’s about being smart with your spending.

warren buffett

If frugality works for billionaire Warren Buffett, it can work for you. Photo: Fortune Live Media

Dodgy Piece of Advice #5: Following a Budget is Essential

Many personal finance writers suggest using a formal budget as a tool for getting your money straight. Their books or articles will include some sort of template for making a budget and the writer makes it sound like filling out this form is essential for getting your finances in order.

It’s not.

Don’t get me wrong – a budget can be a powerful tool. I’ve used a budget for many years, on and off, as a way to get a “big picture” of our spending and where our money is going. If you build one correctly, it can provide a powerful window into where all of your money is actually going. In fact, here’s my original guide for making a budget along with some tips for making that budget great.

However, just because it is a powerful tool doesn’t mean it’s right for everyone. A budget tends to work best for people who are very analytic and are comfortable with numbers and charts. For many people – including myself – sensible arrangements of data convey a lot of meaning and can directly relate to other aspects of life.

For other people, that connection doesn’t really exist, and for those people, a budget is an exercise in futility. For people without that connection, other strategies come to the forefront, such as focusing on behavior and spending choices.

You can succeed financially without a budget. It is undoubtedly a powerful tool and it can be incredibly helpful for some people, but it’s not essential.

Dodgy Piece of Advice #6: Buying an Insurance Policy Allows You to Bank on Yourself

One oft-promoted financial strategy is one in which you purchase a high value whole life insurance policy, allow it to build cash value, and then use that cash value as a “bank” of sorts, borrowing money from that policy and then repaying it just as you would with a normal bank.

While this system sounds good on paper, it really doesn’t add up. The actual numbers behind a whole life insurance policy make this strategy either prohibitively expensive (due to the commissions you’re paying on that policy) or ineffective due to the relatively small size of a modestly-priced policy. If you want details on why this system doesn’t work, this article spells it out.

Yet, I often see many otherwise sensible financial writers touting this type of strategy. Sometimes, it turns out that the people touting these strategies are themselves insurance salespeople who stand to make a nice profit from plans like this. Others who tout the suggestion are buying into the brief elevator pitch and don’t look into it too closely.

For me, the “bank on yourself” system is the poster child for looking into the details of a financial idea before getting hyped about it… well, along with multi-level marketing and network marketing schemes.

Dodgy Piece of Advice #7: The Only Way to Build Real Wealth Is Through Entrepreneurship

I am a big fan of entrepreneurship. I think that most people should spend at least some of their time trying to build a side gig, at the very least. Entrepreneurship can be a great way to channel interests and ideas that aren’t met within your normal career and can end up providing more income or even a new career path.

Having said that, the reality is that the vast majority of entrepreneurial endeavors fail and end up costing the business owner time and money. So how do people ever succeed in business? Usually, it’s not money that decides it. It’s a combination of a good idea and a lot of work ethic and sweat equity. Even then, about half of all businesses fail within the first five years, and more fail later on or only become a very modest success.

The reason so many people point to entrepreneurship is because the outliers – the relatively rare people who succeed wildly – are huge outliers. Thousands and thousands of dot-coms start every year, but there’s only a handful that have ever made it truly big.

Not only that, there are many other ways to build wealth. Living frugally and investing your money is a great way to do it, for one. That’s the path Sarah and I are following and we’re walking steadily toward financial independence. Another strong strategy is to build a skill set that makes you highly valuable in the professional marketplace, then using that large salary to invest.

Dodgy Piece of Advice #8: Leverage Is the Best Way to Build Wealth Quickly

For starters, let’s talk about exactly what leverage means here. Leverage means that you borrow money in order to invest it in something, with the idea that the investment will earn a greater return than the interest on the loan that you took out.

If leverage works, it works great. It can generate money seemingly out of thin air, since you don’t actually need initial funds to start earning money. All you need to be able to do is to invest money that returns more than the interest rate on your loans and money just generates itself.

However, when it doesn’t work, things fall apart pretty rapidly. If your investment isn’t returning enough money, you either have to cover the loan payments out of pocket or you have to hijack the investment to keep your head above water for the moment.

Essentially, leverage means you’re multiplying both the risk and the reward of an investment. If it goes well, then the rewards are great. If it goes poorly, then you can quickly be left with a pile of debt.

Many businesses use leverage to get started because they have big dreams and little capital, but in those situations, the actual business owners are protected (to a large extent) by the business structure.

Many financial writers, however, talk about extending the principle of leverage into one’s personal life or into a very small business owned by someone without a lot of money in the bank already. Often, this centers on real estate investing – taking out mortgages to buy more and more and more houses and using the rent from those properties to pay the interest on the mortgages. That works great, assuming you can fill those properties with reliable tenants. If you can’t… it’s going to be a disaster and you’ll have to hope that it doesn’t take you down along with it.

Leverage is a bad idea unless you can make good on any failed loans. If you’re facing debts that you won’t be able to handle. If you even want to think about this, you need to make absolutely sure that you’re not personally liable for the debts, and it is difficult finding a lender who will give out such a loan to a business without a very positive reputation.

Avoid leverage unless you know exactly what you’re doing, and if you’re just taking advice from some financial writer who wrote a few articles about using leverage to generate wealth, you don’t know exactly what you’re doing and need to be doing a lot more homework first.

Dodgy Piece of Advice #9: Fake It Until You Make It

Many career advice books talk about the value of dressing for success – wearing an expensive suit, driving a nice car, and so on – to give the impression that you’re already a huge success and thus money will be attracted to you somehow.

In reality, money is earned by people who have a plan and know how to execute it. It’s earned by people with valuable skills. It’s earned by people who put in a lot of time and sweat equity into their careers and businesses and lives.

The idea of “faking it until you make it” is appealing on some level, but competent people can almost always see right through the veneer. What matters is what’s behind that veneer. Is it a person who’s trying hard to build something successful? Or is it someone who’s skating by with a promise and a false smile?

A nice suit can be useful in a business environment. A nice car can help in some public-facing jobs. However, if those tools aren’t backed up by competence, it won’t take long for wise people to see right through you and that creates an even worse reputation – not only are you less competent than you were billed, but you’re also a faker.

Put on the suit and drive the nice car if it will help, but the most important factor in success is being competent. If you don’t really have the skills, all the flash in the world will eventually backfire right in your face.

Final Thoughts

Even though I’ve pointed out several pieces of suspect advice above, the truth is that the vast majority of advice that I read in personal finance books and magazines and websites is really sensible stuff. However, there are enough questionable things floating around out there that it’s always worthwhile to be on guard. Don’t fully trust everything you read. If you’re going to take action on it, take some time to verify it first.

Good luck.

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