Through Jennifer Nelson, Next avenue
Traditional financial advice like the one you got from your parents is often true, but even experienced investors can rely on outdated maxims that no longer serve your financial well-being.
In fact, quite the opposite, sticking to adages such as “cash is king” (cash is more valuable than other investments like stocks and bonds) and “all debt is bad” can be a financial relic that you can update.
Here are 5 money ideas you can ditch to keep your financial mind young:
1. Pay off your mortgage sooner
One rule that may have become outdated is to pay off your mortgage faster than usual. With mortgage interest rates low, there’s good reason to think that putting that money elsewhere and earning a higher return over time may be a better bet than paying off your mortgage sooner. “Trying to decide between eliminating debt and investing for the future can be a tough decision,” says Jason Laux, retirement advisor at Synergy Group, a retirement planning company in White Oak, Penn.
“But mortgage debt isn’t always a bad thing. If you put off saving for retirement in order to pay off your mortgage sooner, you could end up home rich but cash poor,” says Laux.
Instead, prioritize your personal finances. Use any extra money to maximize contributions to your 401(k) or IRA. “Saving and investing for retirement will give you a better return over time,” says Laux.
2. Cash is king
In the long run, holding large sums of cash ensures that you will incur large opportunity losses, says Robert R. Johnson, professor of finance at Heider College of Business, Creighton University, and co-author of “The Tools and Techniques of Investment Planning, Strategic Value Investing, and Investment Banking for Dummies.”
He explains that when it comes to building wealth, you can either sleep well or eat well. If you invest cautiously, you sleep well due to the low volatility. But this does not allow you to eat well because your account will not grow big enough to keep you well fed.
According to data compiled by Ibbotson Associates, large-cap stocks (think the S&P 500) have returned 10.3% compounded annually from 1926 to 2020.
Over the same period, long-term government bonds yielded 5.5% per year and treasury bills 3.3% per year. To put it in perspective, $1.00 invested in the S&P 500 at the start of 1926 would have reached $10,945 (with all dividends reinvested). That same dollar invested in Treasury bills would have reached $21.71. “The surest way to build wealth over long-term horizons is to invest in a diversified portfolio of common stocks,” Johnson says.
3. You must have a financial advisor
Twenty years ago, if you had disposable income, you gave it to a financial adviser, who invested your money in safe and boring vehicles earning around 7% to 10% a year, says Stefan von Imhof, CEO of alts .co, one of the largest alternative investment communities in the world. “Today, retail investors are increasingly avoiding financial advisors and managing their investments themselves.”
Imhof explains that a decade ago, 57% of households with a net worth over $500,000 and a primary income under age 45 had an investing style that was considered “mostly self-directed.” In 2019, that number jumped to 70%.
“The new generations are self-taught and take higher risks to get higher returns,” says Imhof. They’re looking to invest in alternatives, which isn’t usually an option with traditional advisors,” he says. Today, managing your portfolio alone or with light guidance from an occasional financial checkup with a professional may be the best way to go.
4. Contribute 10 to 15% in retirement
“Of course, this advice will work for someone who plans to work into their late 60s,” says Ty Jones, a personal finance and retirement blogger who blogs at AskTheSavingsGuy, an independence advocacy blog. Fund for Early Retirement (FIRE), “but if you want to retire in your 50s, you’ll have to save a lot more aggressively. »
By saving 25% of your income, a 30-something with no retirement savings could reach their retirement goal at age 55 instead of age 63, which would be the case if they only contributed 15% per year under the 4% rule. and assuming an 8% yield. Increasing your retirement savings from 10% to 20 or 25% can both ensure a stronger retirement portfolio and allow for earlier retirement, Jones says.
5. Respect the 4% retirement rule
This rule says you can spend 4% of your retirement funds per year and still not run out of money. According to Johnson, research, including by Wade Pfau of the American College of Financial Services, shows that while historically this rule of thumb has worked in the United States, the current environment of low bond yields increases the likelihood that retirees will be at risk. short of money. if this rule is applied in the future.