New Jersey bankruptcy lawyer, Lee M. Perlman

new jersey bankruptcy law

Personal Finance Myths

Hate to burst your bubble...

But here are some personal finance myths I hear so much that I have to get them off my chest...

1. Paying tons of Mortgage Interest is WONDERFUL because it is tax deductible

No, no, no, that is the wrong attitude. So many people seem to think it is beneficial to have a huge mortgage so they can have a huge "tax savings". I will lay it on the line. Having to pay interest by itself is BAD! You are being forced to pay more than something is worth because you do not have the cash to buy it yourself. However, with mortgage loans you get to write off the interest as a tax deduction. This is great but it really is not a "savings", it is really a "discount". You are still paying a bucket load of money to borrow for your home, but you are getting a percentage of it back as a discount or rebate. It is not a savings! However, due to the discount, mortgages and home equity loans do tend to be the cheapest way to borrow money, so if you have to borrow it is definitely the way to go. But do not think it is so great to get to pay interest. It simply is not wonderful at all. But if you must borrow, getting a low rate and having it deductible is better than a high rate that is not deductible. So paying deductible mortgage interest is great, only because it is better than the other alternatives (non-deductible high interest, or rent that is essentially flushed down a commode), not because it is so fantastic to be paying thousands of dollars a year to a lender.

2. If you refinance to a lower rate you will save interest long term

For the vast majority of folks this is true, but it is not always. The problem arises for people who have already paid down their mortgages substantially. Let us say you borrowed $100,000 5 years ago at 8% with a monthly principal and interest payment of $733. As you had extra cash you paid down the loan so now it is only $80,000. But now you can get a 6.0% 30 year loan on that $80,000 and only have to pay $2,000 in closing costs, and watch your new payment drop to only $480 month. That slashes the principal and interest payment by $250! How could that not be a great deal? Run the numbers in a calculator. With your current loan, you would pay off the loan in 10 years and pay about $27,000 in total interest. With the new 30 year refi you would be paying for 30 whole years, racking up over $92,000 in interest. The difference is what happens to that extra $250 per month that you save with the new loan. If you were going to pay the loan off in 10 years, you should only look at a new 10 or 15 year loan to begin with, and you should consider keeping your payment at $733 per month anyway if you can afford it. If you refinance to a 6% loan on the $60,000 and pay the same $733 per month, it then gets paid off in less than 9 years and costs less than $18,000 in interest.

3. You pay no interest on a 0% car loan

Here is another great myth. Do you want 0% financing or a $2,000 rebate? Wow, you either pay no interest or you get a great discount! Too good to be true? Of course it is. Look at is from the car dealers perspective. You have a lot full of $25,000 cars and nobody is buying them. In the old days they did what everybody else did, they lowered prices. But now they come up with this great marketing scheme. Think of the person who buys the $25,000 and gets a $2,000 rebate. Did he really buy a $25,000 car? No, he bought one for $23,000. So when the next person buys the exact same car for $25,000 and walks out with a "0% loan" is he paying no interest? Nope, he just paid $2,000 in interest up front. He bought the same $23,000 car and is paying $2,000 in interest spread throughout all his payments. This is not to say this may not be a great deal, for it may well be. But do not think you are paying no interest, because you are. The dealer has to give a better deal to the person paying cash than a person financing, it just makes common sense. If you were selling your washing machine and one person would pay it all in cash and someone else would be paying you in installments, to whom would you give a better deal?

4. All Variable Annuities are a ripoff

The real truth is that MOST variable annuities are a ripoff, especially the ones peddled by well dressed insurance salespeople with lots of nice glossy brochures with pretty graphs in them. These products tend to have very high annual expenses and lots of surrender fees (if you withdraw before a specified time period). Compared to these products it makes much more sense to just invest in no-load mutual funds. But what about no-load variable annuities that charge low annual expenses and no surrender fees? Believe it or not, they exist and are often a better idea than investing in taxable funds for the right folks. All the money grows tax deferred until withdrawn and can also be moved between different asset classes. Some folks argue that mutual funds are better because the gains are taxed as capital gains instead of ordinary income (which gains on variable annuities are), so if you have $50,000 in gains the tax savings would be better with the mutual funds. That is true for variable annuities whose earnings are primarily based on equity appreciation. That is why if you do purchase a low expense variable annuity you should primarily invest it only in investments whose earnings would normally be taxed as ordinary income (i.e. bonds, fixed-income, REIT's). After the recent tax cut, holding equities in a variably annuity does not make much sense anymore but holding bonds and fixed income investments still make sense for some people. The investment will earn income and grow without paying any taxes until a withdrawal is made.

5. People who earn more money/live in expensive homes/drive fancy cars are "richer"

No, it is the people who hold more assets that are actually richer. In general, people who earn more typically hold more assets, but that is definitely not true in many cases. You assume the folks who live in the expensive houses and drive the expensive cars are "rich". Many may hold more assets than you do, but many of them do not. Believe it or not, a good percentage of people you see driving by you in expensive cars may very well hold less net assets than you do since they may be carrying huge piles of debt. The best reading on this subject is Stanley and Danko's great book The Millionaire Next Door. With auto leasing and 60 and 72 month car loans, the "expensive car" phenomenon is the most pronounced, where millionaires will drive by you in their 6 year old Chryslers, and debt ridden but "image savvy" drivers will zoom by in new leased BMW's and Mercedes, and you will never realize it.

6. Always hold stocks long term to reduce taxes

Many financial advisors and such love to tout the importance of long-term holding to reduce your taxes, so that you only pay capital gains tax instead of ordinary income tax. This is true and wonderful, but not the most important thing in the world in the land of investing. Too many people hold bad stocks too long so they will not have to pay ordinary income tax on their gains, and end up not receiving any gains on them. Hey, you did not pay any tax though! Isn't that wonderful? In the past few years with the falling of the market, too many people held tech losers way too long (I am guilty too, I admit it). After racking up huge gains early 2000 we all said "this is great, but I am supposed to hold these for a whole year to save on taxes". Then everything sank like a rock. Don't you wish you paid those ordinary income taxes on those huge gains we had back then? Remember the purpose of stock investing is to receive gains, and hence we have to pay taxes on them. Gains are good! Taxes aren't so good, but you can't have one without the other.

7. Taxes should be fair

One of the big reasons Bush was fighting to reduce/remove income taxes on dividends was because "it isn't fair" to pay taxes twice on corporate income. In truth, it isn't fair, but since when has anything about income taxes ever been fair? Is it fair that homeowners get to deduct mortgage interest but renters do not get to deduct their rent? Is it fair that itemizers get to deduct state and local income taxes and non-itemizers do not? Is it fair that families with children get the child tax credit and childless taxpayers do not? It is fair that someone earning $300,000 pays much more than 10 times as much income tax as someone earning $30,000? None of this is truly fair. However, tax laws are designed by committees of politicans whether we like it or not, and they all compromise to try to come up with laws they think are right but not necessarily fair for the whole country. The only truly fair tax system would be a flat tax, and that has been proposed several times and shot down every single time. Anyone looking for a fair tax system should better look elsewhere.

8. Good investments should always beat the market

It is truly amazing how so many people get hung up about "beating the market". Back in the roaring 90's when the market was returning 15-20% per year, people wanted 25-50%. After the nasty bear slump, you would think people would now be happy to just earn anything positive, but, no, everybody has to beat the average. (just like the mythical Lake Wobegon children who are all above average). So people pay expensive fees for "expert advice", investment newsletters, and extremely narrowly focused funds for that great ideal of "beating the market". What is so horrible about simply matching the market? Yes, I am talking about boring, inexpensive, and unexciting broad index mutual funds and ETF's. With their minimal expenses you are guaranteed to not overperform the market, but instead are guaranteed to underperform the market by a small expense ratio. In reality it has been proven that indexed securities beat the long term performance of the vast majority of more expensive, managed investments, but most folks are willing to gamble that they will be among the lucky few who will outperform them.

A long term return of about 10% just is not good enough for some folks I suppose. It does not sound all that bad to me. In reality, if earning an average of 8 to 10% per year long term on your investments is not enough to guarantee ample income for you in retirement, that simply means you are either not contributing enough or that you should lower your future income goals, not that you should go on some grand search for some mythical above market returns. It is a sad truth that most people simply do not want to face.

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