5 Financial Homilies To Reconsider
March 10, 2011 1 Comment
Financial advice always needs to be nuanced.What is good for one person in a certain situation many not be so good for another in a different situation. Unfortunately people are always looking for simple advice and rules of thumb.If we over-generalize on generally sane financial advice we can come to a sorry pass.
Here are some common homilies that need some reconsideration:
1. A house is always a good investment:A house is a tangible investment that you could potentially live in.You could rent it out and make some money.Maybe it will help you save tax.Maybe you could invest in one to save for retirement.Generally saving for a house to live in is good in that it gets a family to start saving.But at the time of buying a house it’s important to remember that you are buying a house and not a home.So do not go sentimental and over pay.Buying a house requires a deal of legwork and hard-headed thinking.Overpay and you will have to worry about the fluctuation in market prices.Try to buy an encumbrance-free house at a discount.It adds a greater measure of safety to your investment.Buy when the markets are down to safeguard yourself.Next how you pay for the house makes a big difference.Try to put down a large payment to save on the total interest you will pay.Shop around for a good loan if you need one.Read the fine print.Check if there is a penalty on prepayment.Lower rates matter.Also check if the interest is calculated on a declining balance.Check for hidden costs starting from the processing fee,the lawyer’s fee and structural engineer’s fee and insurance.When you consider the EMI you want to pay, don’t be too optimistic.Pay increments and bonuses might not come on time.Remember that over longer periods something is bound to go wrong.It’s the way of life.Also if you pay too much of your income into house payments you will not have any money left over to diversify into other assets and derisk your investments.
2. Avoid credit cards:Interest rates on credit cards are high as they are unsecured debt.In the hands of the financially unsophisticated and/undisciplined credit cards are dangerous.But credit cards do have their advantages.They provide a free source of credit for up to 48 days.Also it’s possible to benefit out of discounts and freebies from retailers.A sensible use of cards can help us actually make a little money on the side.Also they afford a convenience where debit/ATM cards/cash/cheques are not accepted.And frankly in places where most people have cards not having one raises suspicion.So credit cards have a place in life.It’s just a matter of learning to use them.
3. All student loan debt is good debt: Borrowing whatever it takes to go the best school you can because It’s an investment in your future is often self-interested advice.College students and their parents are better off avoiding these loans, rejecting the hype of expensive private schools, and instead paying for more affordable colleges through a combination of scholarships and savings.It’s not so bad working to fund college.It takes a bit longer but is often financially a lot more low risk.If you have decided to earn your bread as an employee it’s often better and less risky to benefit from in-house corporate training rather than paying for expensive tertiary education.
4. Never take a loan against retirement savings and insurance policies:The danger of borrowing from long-term savings is that a person may never pay it back and then may compromise his/her retirement plans etc.But if a person is a good saver and unforseen circumstances have compelled them to borrow and they have the means and willingness to pay why not borrow from these sources which are often cheaper than bank loans.And the interest anyway accrues to the borrower.Also such borrowing might be advised by a tax advisor to save on taxes.
5. Use a loan against your home to pay off credit card debt: Secured loans are always cheaper than unsecured loans and it is a good idea to replace high cost debt with cheaper ones.But more credit is never a solution for people in a credit mess.A person who has got into a huge credit card debt might need to learn discipline or risk mitigation depending on whether they are impulsive spenders or speculators. Showing them the home loan idea before working on the habits that got them into the credit mess in the first place is merely helping them dig themselves deeper into the mess