Outdated Financial Advice That's Still Being Taught
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Date: October, 25 2016
The investment world is littered with quotable expressions passing as legitimate investment advice. "Buy what you know" is an expression commonly thrown around about investments, but it may not be sound financial advice. It can cause problems for investors when inaccurate or outdated expressions become commonplace. Understanding the source and the legitimacy of financial advice is an important step toward building a solid financial plan.
Use Your Age to Allocate Your Portfolio
One oft-repeated bit of financial wisdom is that you should use your age to determine your portfolio's stock allocations, investing the remainder in cash and bonds. Although the overall principle of this maxim may be prudent — you should shift your investments to a more conservative tilt as you age — the actual numbers no longer add up. Each investor's financial situation is unique. Age alone cannot accurately determine portfolio allocation because it doesn't take into account an individual's entire financial picture.
Perhaps more importantly, people are living longer than ever. Many future retirees have 30 years or more of retirement awaiting them, and not placing enough money in growth investments, such as stocks, may leave them running short on funds as they age.
Plan on 4 Percent Withdrawals in Retirement
Retirees have traditionally been told that they could safely plan on taking 4 percent per year out of their retirement accounts. This may work for some investors, but not all, and not all of the time. If your investments are allocated to ultra-conservative options, such as money market accounts, you might run out of money before you reach the end of your life. This is particularly true since people are living longer.
Conversely, if your investments are too aggressive, sticking to a 4 percent withdrawal schedule could also be problematic. If your account drops in value by 20 percent, your 4 percent withdrawals might only last 20 years instead of 25. Although 4 percent may be a good general rule, each investor has to be flexible with it.
Buying is Better Than Renting
Common financial wisdom is that it's always better to buy than rent, whether it's a home or a car. This maxim is based on the belief that owning an asset creates wealth, whereas renting is simply an expense. In some ways and in some cases, buying can be better than renting. But sometimes renting can be a superior choice to buying.
A car lease, for example, allows you to get a new car every three years or so. During that time, your maintenance is often paid for by the car company. Your monthly lease payment will also frequently be cheaper than a finance payment.
The same principles hold true with renting versus owning real estate. As a renter, you're generally not liable for the maintenance and other expenses associated with the property, and you don't have to find a buyer when you want to leave. Although you won't get a tax benefit from your monthly rental payment, it can be cheaper than a mortgage payment.