By Jennifer Nelson, Next Avenue
Traditional financial advice like the kind you got from your parents is often true but even experienced investors might rely on maxims that are outdated and no longer serving your financial well-being.
In fact, quite the opposite, as sticking to adages like “cash is king” (money is more valuable than other investments like stocks and bonds) and “all debt is bad” may be financial relics that you can stand to update.
Here are 5 money thoughts that you can ditch to keep a young financial mind:
1. Pay Your Mortgage Off Early
One rule that may have become obsolete is paying down your mortgage faster than usual. With mortgage interest rates low, there’s a good argument that putting that money elsewhere and earning a higher return over time may be a better bet than paying down your mortgage early. “Trying to decide between eliminating debt and investing for the future can be a difficult decision,” says Jason Laux, retirement advisor at Synergy Group, a retirement planning firm 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 early, you may end up house rich but cash poor,” says Laux.
Instead, prioritize your personal finances. Use any extra money to max out contributions to your 401(k) or IRA. “Saving and investing for retirement is going to offer you a better return over time,” Laux says.
2. Cash is King
Over the long run, holding significant amounts of cash ensures that you’ll suffer significant lost opportunities, explains Robert R. Johnson, professor of finance at Heider College of Business, Creighton University, and the 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 conservatively, you sleep well because of little volatility. But it doesn’t allow you to eat well because your account won’t grow large enough to keep you well-fed.
According to data compiled by Ibbotson Associates, large capitalization stocks (think S&P 500) returned 10.3% compounded annually from 1926 through 2020.
Over that same time, long-term government bonds returned 5.5% annually and T-bills returned 3.3% annually. To put it in perspective, $1.00 invested in the S&P 500 at the start of 1926 would have grown to $10,945 (with all dividends reinvested). That same dollar invested in T-bills would have grown to $21.71. “The surest way to build wealth over long-time horizons is to invest in a diversified portfolio of common stocks,” says Johnson.
3. You Must Have a Financial Advisor
Twenty years ago, if you had disposable income, you gave it to a financial advisor, who invested your money into safe, boring vehicles earning roughly 7% – 10% per year, explains Stefan von Imhof, CEO of alts.co, one of the world’s largest alternative investing communities. “Today, retail investors are increasingly shunning financial advisors, and managing investments themselves.”
Imhof explains that a decade ago, 57% of households with $500K+ in net worth and a prime earner under 45-year-old had an investing style considered “mostly self-directed.” By 2019, that number has shot up to 70%.
“New generations are self-educating and taking on higher levels of risk to get higher returns,” says Imhof. They look to invest in alternatives, which usually aren’t an option with mainstream advisors,” he says. Today, managing your portfolio on your own or with light guidance from an occasional financial check-up with a professional may be the preferred way to go.
4. Contribute 10-15% Toward Retirement
“Sure, this advice will work for someone who plans on working until their mid to late 60s,” says Ty Jones, a personal finance and retirement blogger who blogs at AskTheSavingsGuy, a Financial Independence Retire Early (FIRE) advocacy blog, “but if you want to retire in your 50s, you’ll need to save much more aggressively.”
By saving 25% of your income, a 30-year-old with no retirement savings could reach their retirement goal by age 55 instead of age 63, which is what it would be if they were to contribute only 15% per year based on the 4% rule and assuming an 8% return. Bumping up your 10% percent retirement savings to 20 or 25% can ensure both a more robust retirement portfolio and allow for earlier retirement, explains Jones.
5. Stick to the 4% Retirement Rule
This rule says you can spend 4% of your retirement funds annually and not run out of money. Johnson says, research, most notably by Wade Pfau of The American College of Financial Services, shows that while historically that rule of thumb worked in the United States, the current environment of low bond returns increases the likelihood that retirees may well run out of money if that rule is applied going forward.