10 IRRATIONAL BELIEFS ABOUT MONEY THAT ARE HELD BY EVEN THE SMARTEST PEOPLE I KNOW
Securing your retirement requires mastery of invisible forces like compound interest, opportunity cost, inflation, fungibility, and fees. But we are bad at understanding things we cannot see.
- 1."My house was a great investment! I paid $500K for it in 1993, and now it's worth a million dollars."Yes, and all of the following were also great investments: milk; cinnamon buns; ferrets. Your house doubled in price because EVERYTHING doubled in price. And contrary to popular belief, the average home over the very long term has virtually no expected or historical return beyond inflation. If it did, then pretty soon nobody would be able to afford a home.
- 2."I got a free first class upgrade using my airline miles!"Miles are equivalent to cash—just check the airline's balance sheet. Any time you behave differently with points than you otherwise would have with cash, like buying an upgrade or picking a different brand, you've already lost. The currency swap disorients people, like the time my aunt was thrilled to find a Pirates of the Caribbean garter belt for "only" 17 Disney Dollars.
- 3."I got a sick hotel suite using my Starwood points!"See above.
- 4."My financial advisor is doing great this year. I've made $75K."Many people seem to think that "up" is the sole barometer of investing success. But if the benchmark is up 50% and you're up 20%, you're doing terribly. Note: If you have a financial advisor at all, the statistical odds are that you're not doing well (because he's anally probing you with hidden fees.)
- 5."Would you like to donate $1 to the Underprivileged Lemurs foundation?" "Ok."Donating at a checkout counter is not going to be the most efficient route to any charity, where "efficiency" is defined as "the amount of money that stays between you and the charity instead of going to Visa/Whole Foods/the government." More generally: If someone is asking you a yes or no question about your money, "yes" is going to hurt you in some non-obvious way. Financial products should be bought, not sold.
- 6."Wow, I just got paid a huge dividend from my stock or mutual fund. This is awesome!"Lots of people think dividends are free money. They're not: Before a dividend is paid to you, it sits in the company's bank account, meaning it is reflected in the price of your stock. Once it's paid out, the stock price falls by an equal amount. So at best, a dividend is neutral for you. At worst, a dividend is negative for you, because you have to pay immediate tax on it that will no longer stay invested and compounding over time. In short: dividends are BAD.
- 7."I'm boycotting X because I don't like their business practices. I use Y even though it's more expensive."Let's say Lyft is on average 10% more expensive than Uber, and let's say you spend $1000 on rides a year. So you're spending $100/year extra to stick it to Uber. If you're 30 years old, and you had otherwise reaped and invested that $100/yr at 7% return, it would've grown to $15K nominal when you retire. Now, if you had to pick the worthiest cause to donate $15K to when you retire, would you pick the "death to Uber" cause over cancer, AIDS, and all others? No? Well that's what you're doing here!
- 8."Don't rent! You're throwing your money away!"You can't compare a typical home purchase to a rental, because when you buy a home with a mortgage, you are leveraging. If you make the comparison fair (by either leveraging or deleveraging both scenarios), renting wins out a lot more often than people think. That's because you can invest the bulk of your money in the market instead of in your home, and the market has a higher expected long-term return than real estate. The NYT has a great buy vs rent calculator for this.
- 9."I invested $50K in my friend's underwater toaster company five years ago and shockingly it failed. But he's paying me back, so at least I didn't lose anything."The market is up 83% over the last five years, and your money missed that opportunity. You lost $42,000.
- 10."My advisor is a family friend, so he only charges me 1% a year."If you invest $300,000 at the outset plus an additional $30,000 a year, over 35 years, at 7% return, then using an advisor will ultimately cost you 1.8 million dollars by the end. That's approximately 25% of your final sum; compounding can be a real bitch. P.S. Your advisor's direct fee is just one of many ways you're getting screwed; I'll do a list of the others if people care.