The world and various media channels are chock-full of financial advice for you -- but not all financial advice is good advice. Here are three nuggets that our contributors find rather problematic.
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Expect a 12% return and withdraw 8% per year in retirement
- The S&P 500 had average historical returns of 12% per year. As such, investors should put 100% of their nest egg in mutual funds that can deliver that return, often with a heavy sales load to boot.
- Assuming inflation is below 4%, retirees could then take out 8% of their nest egg in their first year of retirement, adjusting that for inflation every year thereafter.
This is advice is not supported by actual facts. The truth is that the S&P 500 has a compounded annual growth rate (CAGR) of 9% dating back to 1871.This 3% difference might seem benign, but small changes can have a huge difference. To give you an idea, here's what would happen if you invested $5,000 every year between age 25 and 65, with a 12% return and a 9% return.
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The actual dollar amount doesn't matter. The bottom line is that -- over 40 years -- you'll have less than half of what you expect. I've also heard from several financial planners that some clients refuse to invest with them because they won't guarantee 12% returns -- which leads them into the hands of planners who knowingly promise unrealistic results.
But perhaps the worst part of the advice is that you can safely withdraw 8% annually. I've already shown that in the past, following that advice would mean that you'd have a 50% chance of going broke by age 90. And if you retired in 2000, you would have been left penniless by 2009.
That alone is all you really need to know about why this isn't sound advice. Expecting 8% returns, and assuming you can pull out 4% in retirement, will lead to much healthier investing and withdrawing behavior.
Starting early can make it easier to build wealth. Image source: Getty Images.
You needn't save money when you're young
Jason Hall: About a year ago, an article advising people in their 20s to not save money went viral. And quite frankly, it was one of the most short-sighted, ignorant pieces of bad advice I've seen in my entire life.
And not just because it was terrible financial advice; frankly, that may have been the least bad thing about it.
In short, the author seemed to draw a conclusion that saving was binary, and zero sum: Either you could save money and be unhappy, since you couldn't do anything else, or you could stop saving and be happy, since you could go eat out and party with your friends.
The big problem? This mindset totally disregards the value of finding balance between thinking about the long term and building up a safety net, and enjoying the here and now. The reality is that millions of young people will succeed or fail based on the habits they create and actions they take in their 20s. After all, the longer you put off saving -- and developing the habits that make it sustainable -- the harder it will be to start forming those habits as you age.
Besides -- and this is maybe my biggest beef with this advice -- life doesn't end at 30. By far, many of my happiest days and best experiences have happened after I turned 30, and in no small part because I didn't take this terrible advice and ignore the future.
Lastly, it doesn't take a lot of money set aside at a young age to really pay off later in life. If you invested $600 per year in your 20s in an S&P 500index fund, you'd have $150,000 extra in retirement savings at age 65. That's right; setting aside only $50 per month during your 20s -- $6,000 total out of your pocket -- could be worth $150,000 when you retire.
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Be a homebuyer, not a renter
Selena Maranjian: A particularly bad piece of advice that's often bandied about is that it's better to buy a home than to rent one. This can certainly seem to make sense. After all, paying rent can seem like pouring money down the drain, as you don't end up with any home equity for all your trouble. But remember, you do get something in exchange for all that money: You get a roof over your head.
And renting has its advantages, too. When you rent, you're not responsible for a whole host of expenses, such as property taxes, maintenance, and repairs. If the roof leaks or the water heater breaks, you won't suddenly face a significant unexpected expense. You won't have to pay insurance on the home, either, which can often top $1,000 per year. (Getting renter insurance for your belongings is a good idea, though -- and it should cost a lot less than insuring the building.)
What about the argument that buying a home is a good investment? Well, it can be. But on average, over the long haul, real estate doesn't tend to appreciate nearly as rapidly as stocks and other investments. You might make a killing when you sell your home, but you might lose money, too -- especially if you haven't stayed in it long enough to recoup closing costs. Meanwhile, since renting is often less expensive than buying, you may have more cash on hand if you're a renter, and you could invest that difference in stocks, earning a meaningful return over the years.
Buying a home is not a stupid thing to do, but it's not likely to be your best investment.
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