Industry Focus: Financials edition host Michael Douglass and Fool.com contributor Matt Frankel look at common misconceptions about homeownership, retirement, investing, credit cards, and Social Security. They discuss what many people incorrectly believe, and the truth behind each of the myths.
A full transcript follows the video.
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This video was recorded on Nov. 27, 2017.
Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, Nov. 27, and we're talking about five pervasive money myths that are just plain wrong. Of course, you probably could tell that already, since I called them myths, but I really liked that as a lead in, so we're going to roll with it. I'm your host, Michael Douglass, and I'm joined by Matt Frankel. Matt, how was your Thanksgiving?
Matt Frankel: Just great. I'm trying to get back into the swing of things. It's always tough after a long weekend.
Douglass: Yeah, I think we all had a little trouble waking up this morning. Before we hop into these myths, I'm going to mention some resources on the episode, as you can imagine. If you want any individual one, that's great. If you want them all, just tell me that you want everything from the money myth episode. Either way, shoot me a note at email@example.com, I'll be happy to provide that content. We publish a lot of great content on Fool.com, and I want to make sure that, as podcast listeners, you're aware of some of the best stuff out there. With that, let's hop right in.
Myth No. 1: Buying a home is always a good investment.
Frankel: Yeah, any time you hear the word "always" in a financial statement, odds are it's somewhat of a myth. It's important to know the difference between investing in real estate and buying a home. If you buy an investment property where someone else is paying you rent, you're using that to pay down the mortgage, pay the bills, you're not paying anything out of pocket to own it, that's an investment and it can actually be a pretty lucrative one over time. On the other hand, buying a house -- it's a home. In a lot of cases, it's more expensive to buy than to rent. It's not true by me. I know in a lot of metropolitan areas, I think at Fool HQ, it's a high-cost market, so it's a little expensive to buy. Anyway, homes have historically appreciated by about 3% annually over time. This is not a great investment return. Stocks generall, over long periods of time return 9% to 10%. Bonds are in the 4% to 5% range, historically, over long periods of time. So it's kind of a fallacy that it's a great investment. There's the argument that you're building up equity as you pay down the mortgage, which is somewhat true if you're not paying that much more to own the house than you would to rent a comfortable home. If you are, you're far better off investing the difference.
Having said that, there are other reasons to buy than just financial. For example, in the neighborhood I live in, there are simply no homes available for rent. So there are very good reasons to buy. Michael and I both are homeowners. We should say that in full disclosure. But, for an investment is not one of those reasons.
Douglass: Yeah. I think this is one of the key mistakes that a lot of people make when they're thinking about home buying -- they assume that it is financially better, always, than renting. The fact of the matter is, owning your own home comes with a lot of benefits that aren't financial, potentially. There's something nice about being able to paint things any color you want indoors. There are benefits to knowing that you're not going to get kicked out next year because the landlord decided they were going to sell the property that you were renting. There's the benefit of knowing that your costs are generally going to be about the same year to year. Of course, real estate taxes change, there are other things that change, too, but generally speaking, your mortgage is pretty much going to be the same as long as you're on a fixed rate mortgage.
But, the fact of the matter is that most of those reasons aren't really explicitly financial. It was interesting, actually: When Haley and I were -- Haley is my wife, by the way -- talking to realtors about buying our first house, we received some literature. There was this one piece of paper that said, "five great financial reasons to buy a home." And three of them weren't financial at all. And I was just flabbergasted, because I just thought, come on, let's just be honest and up front about the fact that there are nonfinancial reasons to buy a home, and that's totally fine.
Frankel: Yeah, definitely. My wife and I have two dogs, which severely limits your options for renting, which anybody who's trying to rent -- especially with a pit bull like we had when we bought our house -- anyone who's tried to rent a place with a pit bull can tell you it's not easy. So, things like that definitely make buying a preferable option in many cases. We have children, we want them to grow up in the same place without fear of having to move every year if the landlord sells our house. So, things like that are reasons to buy. I don't recommend spending more than your maximum budget because you think it's a good investment. That's where this breaks down, too. A lot of people buy as much house as they can possibly afford because they think that's the best way to invest, which isn't true. You're better off buying what you need and investing your extra money either in stocks or bonds or mutual funds, or something like that.
Douglass: Exactly. Now, we've done a very lightweight look at this. If you want more detail on this, Fool.com's managing editor, Anand Chokkavelu, my boss, actually wrote a piece pretty recently that really breaks down the five numbers you need to look at to decide whether buying a house makes better financial sense than renting. If you're pondering that decision, or heck, you just want to think through it and read a really good piece that can help you think through that in the future, shoot us an email at firstname.lastname@example.org: I'll hook you up with the article. That can really help you think through how that might apply to you.
With that, let's head on over to myth No. 2: Retirees should always avoid stocks. This one is particularly potentially damaging, because so many retirees are relatively short on money, and stocks can help make a difference in retirement.
Frankel: It's absolutely true that retirees should scale back their exposure to stocks. We're not saying that at all. I'm not recommending retirees have 80% of their money invested in the stock market. However, especially in a low-interest-rate environment like we're in right now, where bond yields are 2% to 3% if you're lucky, it can be tough to even keep up with inflation over time if all you're invested in is fixed income or, even worse, cash investments. You're going to have some volatility in stocks. That's true. But, it's definitely a risk/reward thing where the reward makes more sense.
Douglass: Yeah. And the fact of the matter is, good quality, conservative dividend stocks provide a reasonably safe cushion. Dividend Aristocrats, which we've talked about a few times on this show, but just as a refresher, they are stocks that have raised their dividends at least once annually for at least the last 25 years. They're household names like Coca-Cola, Johnson & Johnson, companies that pretty much, not all of them, but generally a lot of people have heard of. These are companies that, theoretically, you can get a 2% to 3% dividend, pretty similar to what bonds are paying right now, and potentially there's some capital appreciation as the actual stocks hopefully increase in value over time as well. Of course, you have to pick good businesses. Don't just search for the biggest yield. But, there's an opportunity there for people who have a little bit more of a risk appetite.
By the way, if anyone listening still needs the list of Dividend Aristocrats, drop us a note at email@example.com. I shared an article about this a month or a month and a half ago, but anyone new or anyone who just didn't listen to that episode, feel free to drop us a note and I'll be happy to send that along. There's also kind of a mini-myth buried in this idea of stocks, which is that bonds are safe for retirees. And that's not always necessarily the case, either.
Frankel: There's a few reasons why this is a good mini-myth to debunk. First of all, bonds are like stocks in that there is a wide spectrum of risk within the asset class. The Dividend Aristocrats that Michael just mentioned, and buying a stock like Netflix or something even newer and riskier, that's two different things in terms of risk. Also, there's two other forms of risk you need to know. There's always some level of default risk, unless you're buying U.S. treasuries, which...
Douglass: Yield nothing.
Frankel: ...yield next to nothing, or, as interest rates rise, the actual dollar value of your bonds could fall. Now, if you buy a bond that's paying 3% for $1,000, you're going to get your $30 interest payment every year until it matures or until it's called. That's a given, that's not the risk. The risk is, as interest rates rise, and investors can now buy bonds that are paying 5% to 6% or more, that $1,000 face value of the bond can decline. Which, if you have to sell, can be a big problem. If you buy a 30-year Treasury and interest rates rise 2% or 3%, the face value of that bond could be down to $600 or $700, not $1,000, pretty easily. So, that's a big risk. Again, generally, bonds are not as volatile as stocks, and your interest payments are much more secure than the dividends of even the most secure dividend stocks. But there is that default risk and the interest-rate risk that investors need to be aware of.
Douglass: Particularly given that interest rates, over the coming few years, look poised to actually increase. Now, if you asked any serious stock market watcher three years ago, they probably all would have said the same thing. But, it looks like the Fed is actually beginning to hike interest rates, so it looks like we're going to head toward a higher-interest-rate environment. Not necessarily a high-interest-rate environment by any stretch, but higher than it's been. We've been in a historically low-interest-rate environment pretty much since the Great Recession.
With that, let's head over to myth No. 3: You get what you pay for.
The other way of putting that is, if you spend more, you'll get more. That you pay up for quality. Of course, that's true in the consumer world, and that's one of the reasons why this is such a pervasive and powerful myth. Generally speaking, more expensive shoes are better quality. The same as cookware, the same with TVs, as I just learned. But, the fact is, it's just not necessarily true in investing.
Frankel: Right. The glamorization of hedge funds over the last couple of decades has perpetuated this myth. Those are some of the highest-fee investments in the world, and people just think that because people are billionaires and investing in hedge funds that they're making tons of money, that if they find some high-fee investment like that, they will too. Unfortunately, it doesn't work that way. Most people would be better off sticking with a low-cost index fund, which charges next to nothing. Even actively managed mutual funds, for the most part, underperform passive index funds. Now, their fees aren't comparable to a hedge fund, which will charge you 2% of assets plus 20% of your gains. But, even if you're talking about a 1% expense ratio with a mutual fund vs. an S&P index fund that's charging 0.05%, that eats away at your gains over time.
Douglass: Yeah, in a really big and meaningful way. Actually, Warren Buffett pretty famously ended up in a bet against a hedge fund guy. It was a 10-year bet with $1 million on the line basically saying, would a Vanguard index fund beat whatever hedge funds this guy picked? And while the bet hasn't quite wrapped up yet, it's very close to it, and Warren Buffett is winning by a landslide. So, passive indexing really does, generally speaking, tend to work.
Frankel: Right. There's some bias to that. The general idea was, it was tied to about 200 different hedge funds. The guy he bet against picked five baskets of what are called "funds of funds" that are each a bunch of different hedge funds contributing to the pot. So, it was really over 100 hedge funds that were contributing to this bet. And Buffett's idea is, some of the hedge funds are going to outperform the market over time, some of them are going to underperform, but because they're charging these hefty fees, by definition the gains and the losses will cancel each other out and you'll just be left paying the fees. So you're better off just not paying fees and not doing anything, and investing in the overall market.
Douglass: Right. If you want to learn more about what fees could be in for your portfolio, I actually wrote a piece of couple of years ago on this exact topic, titled How 12 Minutes Could Save You $60,000. The punchline is basically, this is strictly by reducing your investing fees. If you want to learn more, drop us a note, firstname.lastname@example.org.
Alright, let's head on to our last two myths. Myth No. 4: You have to carry a balance to boost your credit score. That's specifically talking about carrying a balance on your credit card month to month to boost that credit score.
Frankel: Yeah. There's some truth to this myth in the sense of the way it's started, that you need to use your credit card and credit to maximize your credit score. That doesn't necessarily mean carrying a balance. That could mean, every time you fill up your car with gas, paying with your credit card, and paying it off at the end of the month. Creditors definitely want to see you using it for obvious reasons. They want to know that you can handle it responsibly. But you don't need to carry a balance to show them that you're doing that. And it's really easy for credit card balances to get out of control really quick. Even if you just keep a small balance, the interest on credit cards is three or four times what you'll pay on a mortgage or car loan. So, you're paying a relatively high amount of interest, even on a small amounts of credit card debt, and it's just unnecessary to do this.
Douglass: Yeah, it's interesting. People often get the idea of utilization -- that's actually using debt in some way -- conflated with this idea that you have to be carrying that debt month to month. With a credit card, basically, if you put some stuff on it, maybe it's lunch, maybe it's dinner, maybe it's, as you mentioned, Matt, gas or something else, and then pay that off each month, you're achieving utilization of your credit card. You're using it. So, the credit bureaus will report that you are using credit. But carrying it doesn't do anything.
Frankel: Yeah, in the credit report, there's two figures you'll see in each credit card listing. You'll see your current balance, and you'll see what's called the high balance, which is how much you have ever used. Not necessarily your carry balance, just how high your balance has gotten. So, through that, creditors can see that you're actively using your credit cards, or that you have been using your credit cards. You don't need to actually have a current balance in order to do that.
Douglass: Yeah, exactly. And I will say, for the record, it's important to have debt for your credit score. When I bought my first car, I had no credit score, and it was a lot harder for me to get a loan as a result. So, it's certainly a useful thing to have a credit score and to have carried some debt to do that. But you don't have to keep a credit card balance month to month to achieve that. I think that's really the key thing to keep in mind. It's great to have a credit card it's not a good idea, generally speaking, to carry a balance on your credit card.
With that, let's head on over to myth No. 5. This one is kind of a different myth from the others, because if people believe it, it might be in some ways better for them. We'll get to that in a minute. Myth No. 5: Social Security is going broke.
Frankel: Yeah. This is one that, in all honesty, I asked Michael to include in the show because it bothers me a lot, just because of the sheer number of people, especially the younger generation, who believe it. The reality is, Social Security has nearly $3 trillion in reserves. That's enough that if we stopped charging Social Security tax and did nothing else, it could sustain the program for several years. Not only that, Social Security is actually running a surplus right now. Social Security brought in, I think, about $35 billion more than it paid out last year, and it's expected to do the same over the next five or six years. It's beyond that where the problem is. So there's some truth to this myth in that eventually, the number of retirees is going to grow, and it's going to be paying out a little bit more. But Social Security is not close to broke right now. The latest forecasts say, by 2044 is when it will run out of reserves. And keep in mind, there's still going to be payroll tax flowing into it. So, worst-case scenario, you'll see Social Security benefits have to be cut by a quarter. Social Security is not going completely broke or bankrupt, or whatever people want to say these days. It's just not true. That's almost $3 trillion and growing in Social Security's reserves.
Douglass: Yeah. What's interesting about this issue is, as you pointed out, even in the worst-case scenario, which is that no one -- not Congress, not anybody else -- no one figures out a way to fix the system or do things differently, and no one does anything at all, eventually the reserves will run dry. That is true. That's definitely going to happen at some point. But, even so, that would just necessitate a benefit cut. Of course, a benefit cut is a bad thing, to be clear. But it's not nearly as bad as Social Security going completely insolvent and not paying out at all. That's just really not on the table.
What's interesting about this is, at least for me, and Matt, I think this is probably true for you, too, I actually try to invest as if Social Security were going broke. Basically, my idea is to have enough money for retirement so that I'm not dependent on Social Security. I'm not thinking about Social Security. So whatever amount they're paying in benefits is gravy. It's icing on the cake. It's "insert other food metaphor." Instead, I can merely focus on living through my golden years and really enjoying them, and not be concerned about what might happen with a funding mechanism or a cost of living adjustment for Social Security, but really have enough in my savings that that's just not a concern.
Frankel: Right. This was what Michael was talking about, how this could actually be a good myth, in many ways, if you believe it. I'm 35. If I believe Social Security isn't going to be there when I retire, then I'm going, "Oh no, I'd better save a lot more for my retirement and build up a nice nest egg," which is honestly what people should be doing anyway. So in many ways, this is a very good myth, in terms of the effect that it could have.
Douglass: Yeah, exactly. If you're interested in learning more about Social Security and what the future holds for it, and potential ways to mitigate or change what's going on right now, and what looks like an inevitable deficit for Social Security, drop us a note, email@example.com, and I'll be happy to send you some content around that from fool.com.
Alright, folks, that's it for this week's Financials show. Of course, I mentioned a lot of different content. If you want it all, shoot me a note, say, "Hey, I want all of the content about the myths," and I will be happy to put that together for you. If you have questions or comments, you can also reach us at firstname.lastname@example.org, we love love love hearing from listeners. That's why I ask you to email every week, because we want to hear from you. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Michael Douglass. Thanks for listening and Fool on!
Matthew Frankel has no position in any of the stocks mentioned. Michael Douglass owns shares of Johnson & Johnson. The Motley Fool owns shares of and recommends Johnson & Johnson and Netflix. The Motley Fool has a disclosure policy.