WE MAKE ALL KINDS of financial mistakes: spend too much, borrow too much, buy expensive investment products, try to beat the market. To be sure, there are some folks who simply don’t know better. But others give the issue serious thought—and still act foolishly, justifying their behavior with cockamamie arguments. Here are five such justifications that I’ve heard in recent months:
1. “It’s okay to spend money if it cheers me up.” This is the crack cocaine school of budgeting. You have a rough day, splurge a little and briefly feel better. But the thrill doesn’t last long, so soon enough you’re back at the store, taking another hit.
2. “I may not beat the market, but it’s fun to try.” I wouldn’t banish you from investment paradise for buying a few individual stocks with a small portion of your portfolio. But if you start betting a large chunk of your wealth on individual stocks and actively managed funds, the potential long-term cost is huge. Let’s say the stock market returns 6% a year, with indexers earning 5.9% and your active strategy clocking 4.5%. If you invest $5,000 a year for four decades, you’ll end up with some $560,000, versus $800,000 for an investor who indexed.
3. “Mortgages are so cheap you should always have one.” Yes, mortgage rates are low—but they’re still above what you’ll likely earn on a high-quality bond portfolio. For instance, 30-year mortgages today are charging an average 3.9%, while 10-year Treasury notes are yielding just 2.2%. True, mortgage interest is tax-deductible. But if you own Treasurys in a taxable account, you’d have to pay federal income taxes on the interest you earn. The upshot: If you own conservative investments in your taxable account—or you’re tempted to buy them—you’ll almost always be better off paying down your mortgage instead.
4. “This guy from the insurance company must know what he’s talking about.” The guy from the insurance company says what he has been taught to say, and probably has very little clue whether there’s any virtue to the product he’s hawking. I don’t believe most financial salespeople are crooks. Rather, they’re just trying to make a living and that means selling whatever they have on the shelves.
5. “If they’ll lend me the money, it must be okay to borrow it.” This is the sort of mentality that leads to maxed-out credit cards and huge second mortgages. Lenders don’t want you to go bankrupt. But they are happy for you to take on so much debt that you’re both a highly profitable customer and a totally stressed-out individual.