Friends and experts often happily share their ideas on how you should manage your money. Sometimes their one-size-fits-all financial advice is preceded by “You’re crazy not to do this…”
And maybe they’re right. But it can be painfully expensive for you if they’re not.
That’s the danger of what we at Millionaire Foundry call common wisdom. Common wisdom are those things that everyone knows works for everybody, all the time.
Until they stop working.
The Great Recession destroyed many pieces of common wisdom, like the ‘fact’ that diversification among real estate, stocks, and bonds will always protect you from a major loss, because all of those asset classes would never go down together.
But they did.
Or that you should always buy the biggest house that you can afford because residential real estate won’t go down more than a few percent at most, and your upside is virtually unlimited.
In 2008-2011, millions lost their houses and ruined their credit when housing values and demand imploded.
Or that you’ll never lose out by buying the stocks of huge companies, like GM, and holding them forever for the dividends.
But those who held common GM stock until bankruptcy lost everything.
Of course there is no source of advice that’s right 100% of the time, especially when it comes to personal finance.
The real tragedy of one-size-fits-all is that it seems to make sense and it often provides an easy answer that lulls us into thinking we’re doing the right thing. But it can be immensely bad financial advice.
Here’s an example.
Let’s say you’re sitting on $20,000 in your savings account and it’s the end of the year. While you’ve contributed to your 401k to get 100% of the employer match, you haven’t funded an IRA for which you’re eligible up to $5500.
A version of one-size-fits-all advice is to fund an IRA for $5500 for the current year, putting 70% of the money in an S&P500 index fund, to expose yourself to reasonable equity risk, and the remainder in a bond fund.
And for some, that’s excellent advice. But for others it could be way off base.
Let’s say you’re 25 years old and want to buy a house next year. Let’s add that the stock market is now in year four of an unprecedented bull run.
If the $5500 you put in the IRA reduces your ability to make your house down payment over the threshold to avoid PMI (private mortgage insurance), and to get a preferred interest rate, the tax savings you experience this year will be a tiny and temporary win against the 30-year burden of a higher interest rate on your mortgage, plus the cost of years of PMI.
And while no one can time the market, many would agree that putting a large amount of fresh money in at the peak of a multi-year run may be exposing you to more risk than is wise.
So in this case, the real danger of the one-size-fits-all advice to open the IRA is that it will cost a lot more than it will save because it’s simply not the right move under the circumstances.
Ultimately, even though it makes sense on the surface, it’s bad financial advice.
Because there are few financial moves that are always right for 100% of people 100% of the time, those who give insightful financial advice will ALWAYS first take the time to learn the specifics of your situation.
Wise financial advisors, before spouting out one-size-fits-all guidance that has its basis in common wisdom, will first ask a series of questions about your current financial status, your short and long term goals, your risk tolerance, and your timeframe.
If you ever ask them “What should I do?”, the sign of an intelligent financial advisor is that their first response will be “It depends.”
In the example I just shared, the right move for the savvy wealth accumulator would depend on the answers to questions like:
- What are your short and long term financial objectives?
- What do you project your income will be next year?
- How much high interest debt are you carrying?
- Do you have a 6-9 month rainy-day account funded?
- At what age do you anticipate you’ll retire?
- What are your current total retirement savings as a percentage of your total assets?
- Do you have any major life events planned in the short term that will require cash, like buying a house, enrolling in college, getting married, getting divorced, or having a child?
- What is your tolerance for risk? Are you willing to risk the possible loss of some of your capital to earn a higher return than a risk free investment?
These are just a few of the questions that should have been asked in order to evaluate if the IRA, with an investment in the S&P500 and bonds, was the right move.
At Millionaire Foundry we believe there are four proven, key wealth drivers to successful wealth accumulation.
But the specifics of how you use them, and Your ‘Right’ Wealth Success Plan, is as unique as your DNA.
One-size-fits-all advice, just like common wisdom, may seem like a fast and easy solution.
But if it stops working, the ride down is often swift and painful.
Not only that, but there’s an extra measure of emotional turmoil that comes from the belief that you did the right things but still got burned.
There were many such cries of financial pain for those who were hurt deeply during the Great Recession’s massive destruction of much financial common wisdom.
You work incredibly hard to earn your money.
You need to treat your cash with the care it deserves because it represents the foundation of your financial future.
Educate yourself to manage your finances because you’ll always have your best interests at heart when it comes to nurturing your growing wealth.
And don’t hesitate to invest in outside, objective advice from an expert, like a fee-only financial planner, who isn’t trying to sell you something.
While you might not use every suggestion they make, their objectivity can help you hone your financial plan to be even stronger.
If your financial planner finds even a small move you can use to grow your wealth faster, the ROI on their fee can be massive.
Learn more about avoiding bad financial advice, as well as successful wealth accumulation, at Millionaire Foundry.
Wealth is Freedom!
A First Generation Millionaire