When Smart Personal Finance Habits Go Dumb
When you start getting your finances in order, it’s exciting. You see the basic concepts and rules of personal finance in action, and after a while they start to bear fruit. This makes it easy to become committed to personal finance. But even the best financial advice can be counterproductive.
Sometimes we try to use these rules when they don’t make much sense. Here are some examples of when sensible personal finance concepts get stupid.
When we’re too excited about interest
Yes, compounding is huge. When you look at numbers, you might be surprised at how powerful complex multiplication is. This is why interest is more important than most people think . And when you earn interest in a savings account or earn interest from investing, it can make a big difference. But don’t let this distract you from smarter financial moves.
For example, while some people are celebrating getting a tax refund, financially savvy people know better. This basically means that you have overpaid the IRS for a year; instead, you could save that money and earn interest on it. It makes more sense to adjust your tax documents and only pay what you owe . But people overestimate how much smarter.
When I heard that my fiancé had received a tax refund of $ 600, I objected, “It’s like giving the IRS an interest-free loan.” And that’s what most people think. But we shouldn’t get too carried away by this interest. Here’s how financial expert Liz Weston reacted to the idea in a recent Twitter chat:
This is true! Most banks pay significantly less than 1% per annum; This means that you are not making that much from overpaying to the IRS (especially if you only get back $ 600 a year). But let’s take a look at the best scenario. Let’s say you invest this money and get 7% interest income (which for all intents and purposes adds up the same way as interest). Let’s also assume that the amount you overpay is $ 250 per month. Here’s what the numbers look like:
A hundred bucks might not be worth sneezing, but this is the best scenario .
Of course, when you overpay for five or ten years, compounding matters more. I am not suggesting that you continue to overpay the IRS. Resize your retention by all means and save every penny – add up! But let’s be realistic: this money move is equivalent to the latte factor . This is a small amount that matters over time. I’m all about it, but a lot of people think it’s a waste of personal finance energy and make a compelling case. If you strive for big wins, you may find it more beneficial to focus your energies on something else.
Compound interest is great, but it shouldn’t cloud your judgment when it comes to making smarter financial moves.
When we do wrong
People often confuse frugality with cheapness. Here’s the difference: thrift is inventiveness; being cheap means saving money at all costs. But because frugality is about being resourceful with money, it can often lead to cheapness.
And the basic clichés of frugality don’t help: spend less than you earn, penny saved, and a hundred others you’ve heard of before. These clichés may be true, but they are not always useful and can get a little out of hand.
More often than not, we go too far by choosing affordability over quality. As our own Alan Henry put it, we live in a commodity culture. Everything is cheap, disposable, and easy to replace. This backfires over time. You are spending more on a few cheap replacement pairs of shoes than on one more expensive pair of quality boots.
Of course, not everyone has the opportunity to choose quality over affordability, but we’re talking about a scenario in which they do that. It took me a long time to learn this lesson because I couldn’t imagine spending more than $ 20 for a pair of boots, $ 25 for a set of pots and pans, and so on. As a result, I changed my stuff frequently and often. I thought I had too much money, but in reality I was quite wasteful. Usually it is more economical to pay for quality.
On the other hand, this advice can also go too far. You can use the “quality over crap” argument to justify an expensive but unnecessary purchase.
So, while saving money can go too far, the argument for spending it can also. The sweet spot is to buy quality when it makes sense and when it fits into your budget.
When we think too much about every purchase
Conscious spending has become a buzzword in the world of personal finance, which is great. It’s all about understanding your spending habits better so you don’t buy unnecessary crap. Most of us buy a lot of unnecessary crap.
But going too far can waste time and effort. It is important to consider each purchase. But time is more important than money, and sometimes I spend an incredible amount of time making very frivolous spending decisions. I recently spent several months deciding whether to pay the premium in full. Yes, it would be great not to worry about it every month and get a little discount. But I let another tricky and then stupid financial move get in the way: compound interest. I asked myself:
- Is it like giving my insurance company an interest-free loan?
- How much could I earn by saving on this money?
- Is the discount worth it?
I actually counted it all, and the numbers were so insignificant that I felt like an idiot. It really didn’t matter much anyway, so after a tedious amount of thinking, I decided to pay the premium and stop thinking about this decision.
When I shop, I do the same. I see a lot in some socks and spend too much time and thought deciding whether to buy them. While it is wise to spend money consciously, it is foolish to spend too much time thinking about socks. To make the most of my time and money, I came up with a rule to help me with my indecision: let’s call it the “10/10 rule.”
If I’m really stuck and can’t decide whether to buy something that is $ 10 or less, I stop thinking and buy it. And if I think about it for more than 10 minutes, it goes back to the shelf again. It’s not reliable, but it helps me avoid overspending without wasting time.
When we spend to earn
There is some truth to this cliché: to make money, you have to spend money . For example, an investment has an initial cost, but ideally it pays off over time, making it a payback. The problem is that we often convince ourselves that frivolous purchases are investments . A fancy $ 1000 suit isn’t an “investment” just because you wear it to your interview.
And then there are rewards. In particular, credit card rewards. The people who earn them love them, and for good reason: You can get free travel packages or cash by using your credit card for your day-to-day purchases and then paying in full each month. To be honest, it’s not exactly the mainstay of personal finance, but financially savvy people are great at using rewards and budgeting with them.
But credit card rewards shouldn’t depend on your financial habits.
I wrote a while ago about going cash-only on Get Rich Slowly. My expenses at the restaurant were spiraling out of control, and paying in cash went a long way in gaining control over them. Several readers pointed out that I was overlooking lost credit card rewards. And recently, when I suggested to my fiancé to reconsider the cash payment method, he asked, “What about a credit card reward?”
Here’s the thing: sticking to my budget is more important than the $ 4 I could earn every month in rewards.
I earn about 1.5% cashback, which is pretty average for a bonus card. I love credit card rewards, but not to the point that they dictate my financial habits, especially at the paltry 1%. This is a bonus, not a budgeting tool.
Personal finance is ambiguous. What works for some may not work for others. That’s what makes it personal . While basic concepts like interest, conscious spending, and thrift should influence your finances, there are many other factors to consider when making the best financial decisions for yourself.