The Broke Professional - Grow your money and yourself

4 Things You Forgot About Personal Finance

mr-forgetful

We all forget simple things sometimes.  The other day when I was trying to login to my system at work, I could not remember my password for the life of me.  I always typed it in without hesitation and without thinking about it.  But for some reason that day I could not remember it.

My memory lapse (aka brain fart) was so bad I even had to get my password reset.  And when I remembered it later that day I couldn’t believe I forgot it in the first place.

But it happens.  We are fallible.  Even billionaires like Donald Trump make mistakes.  Or lots of them.

The same thing applies to personal finance.  I have done so much reading on finance the past few years sometimes I forget the basics.  And I know others do the same.  Life happens and sometimes we can lose sight of what’s important.

So here are four fantastic pieces of personal finance knowledge that we may have forgotten:

1. No interest is better than low interest

It is very easy to get into debt in our society.  If I wanted to, I could just visit a few websites and sign up for a car loan, mortgage and personal loan in just a few hours.  And if you have kneecaps that you don’t mind losing, payday loans are always an option!

Debt has become such a normal part of society, that people don’t really mind keeping “low” interest debt laying around.  This especially includes tax friendly debts such as mortgage debt and student loan debt.  What’s the harm in keeping around a mortgage that is “only” at 4% and where you can deduct the interest paid from your taxes?

The harm is that you are effectively giving the bank a dollar so you can get back a quarter.  If you have the funds to pay off debt quickly, you will be SO MUCH farther ahead if you pay down the principal faster rather than keep the debt around because you can save some money on taxes.  The only one’s getting richer in that situation are the banks.

Debt is so easy to obtain and even more dangerous to keep around, even the “low interest” kind.  Don’t get lackadaisical in  and pay it off as quick as you can.

2. Delayed gratification really works

Awesome personal finance habits can take a while to learn.  That’s why they’re called habits.  Depends on what school of thought/guru you follow, habits can take 21 days, 28 days, 30 days, 40 days or 2 months to fully form.

The bottom line is that they take time, and this really applies to the essential habit of delayed gratification.

But the problem is that our society is very impatient.  We want things now, now now.  And waiting to buy something you want just seems silly to most people.  But if you keep spending money every time you see something you like, you are sabotaging your financial future.

Spending money frivolously means you can’t put extra money towards debt paydown.  It means you can’t make that home improvement you’ve always wanted.  It means you don’t have enough money to start your business.  But if you save money for a period of time and live lean, you can do whatever your heart desires.

The best way to delay gratification is to save until it hurts.  If you’re saving so much money into your retirement plans, savings accounts HSA’s and self education that you can’t seem to find the money to buy that new Apple Watch, you’re doing well.  Just know that over time those accounts will grow and grow and you can do whatever you want with your money

3. Marketers know us better than we know ourselves

Walk into any major department or clothing store in the country, and you will be bombarded by sights, smells and sounds that are engineered to keep you in there.  Lights will accentuate the sharp curves of the newest smartphone.  Catchy music will be playing at a volume that will keep your ears perked up just enough.

And you will quickly forget that you popped into the store to pick up just one thing.

Making a list before going out to help keep your spending under control is a tried and true personal finance hack.  But companies know this and they hire very smart people that know how to keep us engaged.

Knowing this really is half the battle.  We need to realize that these companies need to keep making higher and higher profits every year, so they will keep looking for innovative ways to keep us in the store and handing over our money.  Keep this in mind next time you get caught in their web!

4. Focus on the big wins in life

As the old saying goes, don’t lose sight of the forest for the trees.  Going through life day to day, it can be easy to lose sight of our big goals.  We’ll hear a co-worker or family member talk about this amazing sale or this incredible new way to save some money on groceries.

The fact is, our brain bandwith is finite, so it’s important to keep the bigger goals in mind.  Things like debt repayment, family and friends and spirituality are some of the important things in my life.  But it’s easy to lose sight of that when the latest savings fad or mind numbing game or TV show comes around.

The things that have made people lots of money in the past are pretty much the same things that make people lots of money today.  Getting an advanced degree, building a business, paying off debt and investing are still the best ways to become richer.

Obsessing over things like cutting out lattes and draining the last bit of toothpaste out of the tube will save you some money in the short term.  But it could come at the expense of the real big wins.  Keep your actions geared towards those.

Personal finance has been an evolving subject for me.  I learn new things all the time and that’s really exciting.  But some things I’ve learned on day 1 are still the most important.  Sometimes all you need is a refresher!

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Why Retirement Calculators are Dumb

I don't think Walter White needs 85% of his pre-retirement income.

I don’t think Walter White needs 85% of his pre-retirement income.

When I graduated from optometry school waaaaaaayyy back in 2009, I started to finally make some real honest to goodness money.  I figured I should learn more about this finance thing and proceeded to read almost every personal finance book at the library.

I started to follow awesome blogs like Ramit Sethi’s and Mr Money Mustache.  Being a personal finance novice, I eagerly soaked up whatever information I could.  This led me to be on both sides of the argument on many different issues.

Debt is evil!  But some debt is okay.  Increasing your income is the way to wealth!  But so is being frugal.  While some of my stances on different issues are pretty solid at this point, I’m always learning new things that affect one opinion or another.

But one thing I’ve never liked throughout my financial journey are retirement calculators.  You know, those websites where you input 5 different pieces of information and you’ll find out how much you’ll have during retirement.

I’m not sure why I’ve never liked them initially.  Maybe because retirement was so far away.  Or the fact that I thought I was done with calculators once I got out of school.  But after reading more and more on personal finance, I’ve realized that retirement calculators are downright dangerous.  That’s because they assume you will participate in lifestyle inflation!

Mo’ Money= Mo’ Problems?

I’ve talked about the dangers of lifestyle inflation a number of times on here.  Pretty much it’s when you start spending more once you start making more.  It is the killer of dreams and it’s what keeps most Americans in debt regardless what income class they are in.  Almost everyone would agree it is a bad thing.

But not retirement calculators.  I was fiddling around with my company’s 401k retirement calculator, and at my current contribution rate (maxing it out!) it said I’m on track to have a great retirement by age 60.  Great news.

Then I started playing around with some numbers.  What if I changed my contribution rate?  What if my salary changed?  I found that if I doubled my salary and kept the same contribution rate, my retirement was in danger.  What in the hell?  If I make double the money I will be worse off during retirement?

In what universe does that make sense?  In the sick universe of retirement calculators, that’s where!

The problem lies in a ridiculous “rule of thumb” that keeps popping up:

“You will need 70-85% of your pre-retirement income during retirement.”

This is not an official rule (hence rule of thumb), but it is adopted by most calculators.  The retirement calculator on CNN.com says this:  “We then assume you can live comfortably off of 85% of your pre-retirement income. So if you earn $100,000 the year you retire, we estimate you will need $85,000 during the first year of retirement.”

According to the same calculator if you work hard and end up making $200,000 per year, saving $85,000 for retirement will magically not cut it anymore.  That’s because they assume the extra money you make will be going towards new expenses and not towards things that can actually produce more wealth.

This assumption shows a lot about the mentality in this country as well as the retirement industry.  While it’s good to be conservative and assume you will need more money during retirement, assuming that your expenses during retirement will increase in step with your pre-retirement income makes no sense.

Conclusion

Maybe this is not a big deal.  Maybe I just got offended because a calculator told me my retirement was in danger since I’m making more money than I was before.  It does make sense to be conservative when it comes to retirement.

But what doesn’t make sense is that this rule of thumb is like gospel throughout the retirement industry.  What financial advisors and retirement specialists should be saying is that when you make more income, don’t increase your expenses!

There are so many financially positive ways you can apply your extra income.  You can pay off debt, increase your emergency fund, invest it into equities or real estate or use it to help out a family member or charity.

The idea that you will need more money during retirement just because you are making more before retirement is preposterous.  Studies show most retirees become naturally conservative compared to their working years.  And it’s also important to remember that during retirement you won’t be saving for retirement anymore!  So a huge expense is already gone.

Lifestyle inflation is what keeps most middle and upper class people in the paycheck to paycheck cycle.  It’s a type of hedonistic adaptation that is dangerous because it can keep you from fulfilling your dreams and spending time with the people that matter.  Don’t let a retirement calculator tell you otherwise!

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