There are a large number of personal finance myths that people readily ascribe to even though they could end up hurting them in the long run. Therefore, it is critical to do due diligence and learn about the arguments for and against every piece of advice. With this information in hand, individuals can make the best decision for their own financial futures.
The following are some of the most prevalent myths in personal finance and a look at why the commonly accepted advice may not be as sound as people think:
Pay down debts with the highest interest first.
From a purely economic standpoint, paying down debts with the highest interest rate first makes sense. Doing so saves money over time by limiting the accrual of interest. However, research conducted by the Harvard Business Review suggests that a different strategy may be more effective.
The researchers found that people who paid off their smallest debts first were actually motivated by seeing a balance disappear to redouble their efforts for larger debts. A sense of progress is a powerful tool in personal finance, so it may make the most sense to tackle small debts first, even if they have lower interest rates than their larger counterparts.
Avoid debt at all costs.
While debt can certainly add a degree of stress to a person’s life, it is not something that people need to completely avoid. In fact, there are a number of cases where going into debt can actually pay off financially.
For example, few people have the money saved to afford college tuition, yet earning a new degree can significantly increase one’s earning potential. Thus, it can make financial sense to take out student loans, especially because the interest on federal loans remains fairly low and interest payments are a tax deduction.
In addition, people can put federal loans on hold for a variety of reasons or forgiven in certain cases, such as if the debtor becomes a public servant. Likewise, a mortgage is often a good form of debt since it builds equity and, as with student loans, mortgage interest is tax deductible.
Buying a home is preferable to renting.
Traditional wisdom encourages people to purchase their homes rather than rent them. While there is some real benefit to buying, individuals should not assume that they are wasting money while they rent.
Especially for younger people, renting is often the ideal situation because it comes with much more flexibility. Accepting a great job in a new city becomes much more complicated with a mortgage involved.
Also, a home involves significantly more expenses than just a mortgage, which can limit a person’s ability to save. Renters do not face real estate taxes, homeowners association fees, or the costs of maintaining the property, all of which quickly add up to a major expense on top of mortgage payments.
Budgeting is essential to financial health.
In many ways, budgeting is like trying to lose weight. People start with the best of intentions but then quickly become exhausted or disgruntled within a few months, which can result in some bad behaviors. For this reason, budgeting is a good idea for many people, especially individuals who tend to spend recklessly, but not everyone will benefit from creating and using one. In fact, many people can spend responsibility without a hardline budget.
However, those who choose not to budget should still attempt to pay attention to their spending, just so they are aware of where their money is going. Apps like Mint or LearnVest are great tools for tracking spending and learning more about personal habits. This knowledge can help people curb their bad habits even better than a strict budget can.
Couples should always merge their finances.
Historically, it was almost unheard of for couples not to merge their finances once they were married. Today, however, many couples choose to keep their finances separate and for good reasons. Sometimes, one partner is better with money than the other. Other times, the specific situation, such as the merging of two families, makes it easier to keep finances separate.
The trick to separate finances is honesty. Individuals should not use this system to hide anything from a partner but instead use it to spark open, honest, and ongoing conversations about finances. Another option is to follow a “yours, mine, ours” system where a certain amount of each person’s money goes into a joint account for household and shared expenses.
Having multiple credit cards can lead to trouble.
Many finance experts recommend that people only have a single credit card. But, while having several can seem financially reckless, having more than one can actually help an individual’s credit score.
Part of a credit score depends on one’s credit utilization ratio, meaning how much of the available credit a person is currently using. Ideally, credit utilization should be below 10 percent, but people with amounts under 30 percent are still in decent shape.
The snapshot of credit utilization can take place at any time, so even people who pay off their card each month can have a high utilization ratio if they come close to the limit each month. The ratio, however, takes into account all available credit, so someone who has two cards and brings one close to the limit would still have a utilization ratio under 50 percent.