Why Most Financial Advice is Wrong
I was reading a personal financial advice article a few days ago that caused me to actually yell at my iPhone screen. I couldn’t believe the advice this person was giving – and they write for a major money publication – as a financial planner! Then it occurred to me – much of what is written comes from parrot financial advisors.
What is a parrot financial advisor you ask?Someone who just repeats what they have heard without really thinking about what they are saying… like a parrot, but without the pretty feathers.
The basis of the financial advice went something like this:
Consumer: “My wife and I make $80,000 per year, with $30,000 in student loan debt, $15,000 in credit card debt, $20,000 in car loans, and a $150,000 mortgage. How can we improve our financial situation?”
Parrot Advisor: “Set aside 6-12 months of income for an emergency fund. Start putting an extra 3% into your retirement fund. Set aside some extra money for your kids’ college education expenses, pay extra on your mortgage, and pay at least double your minimum payment on your credit cards.”
Me: “WHAT?!?!? – THAT DOESN’T MAKE SENSE. THIS PERSON WON’T GET ANYWHERE!” (Or something like that)
So what’s wrong with this advice? Emergency funds are good. Retirement investing is good. Paying for college is good. Paying down credit cards is good. Paying down a mortgage is good. How can adding 5 good things together become something bad?
It’s when you add all 5 together that they become bad financial advice! Chocolate is good. Pizza is good. But I don’t want chocolate on my pizza! Okay, bad analogy, but you see the point, right? You can’t do everything at once. Multi-tasking is simply messing up more than one thing at a time.
Let’s consider the advice step-by –step:
1 – $80,000 income – Saving 6 months of income for emergencies = $40,000. Assume they set aside 10% of their take-home pay each month (annual take home pay will be around $60,000 if we are being generous, which is $5,000 per month. I assume the advisor meant take-home pay, not gross income). That comes to $500 per month. Timeframe to achieve goal: 5 years
2 – Put an extra 3% into retirement fund = An extra $2,400 per year going into retirement. This is a good thing. But it depends on if they are already maxing out their matching contribution. If they are, then this is not their next top priority. If they are not, then that should be a top priority under most circumstances. After accounting for the tax benefits, this will reduce their take-home pay by about $1,800 per year or $150 per month,which reduces their ability to achieve their other goals.
3 – Set aside money for college – What great parents! However, can they afford it at this time? Given their own student loans (in other words they haven’t even paid for their own college yet) it seems like that would be a priority over paying for their kids’ college. When you are on an airplane and they explain the safety procedures, they clearly tell you to secure the oxygen mask on yourself first, then assist others. You need a strong financial foundation yourself so you will be in a better position to help your kids through college and other life events.
4 – Pay extra on the mortgage – I wholeheartedly agree that paying off a mortgage is solid financial advice and an important step needed to become totally financially free and be prepared for retirement.But this family is simply not there yet. They have other priorities that need addressed first. Besides, where are they going to get the extra after putting aside $500 per month, plus $180 per month, plus money for college? Maybe they should sell the house and live in a van by the river…
5 – Pay at least double the minimum on credit cards – Why double? Where is this number even coming from? Yes, they should pay extra on their debt. But which debt? What is their strategy?This spaghetti approach to financial management – just throw everything at the wall and see what sticks – doesn’t cut it.
Better Financial Advice – Create a Financial Strategy
The couple needs a financial strategy. They need to create their goals based on specific timelines (how much they want and when they will need it) and break these up into short-term, medium-term and long-term goals. Then they can layout a specific plan to achieve these goals. By prioritizing, they will be able to see which goals can be achieved when, and see if they have enough income to reach their goals. If not, they can then address the issues – either too much going out or not enough coming in.
The point is, telling people to tackle everything at once is terrible advice. You have to take each individual – or couple – into account and see what their goals and priorities are and form a step-by-step strategy to get there. This way they can achieve their goals while tracking their progress. Otherwise, it becomes hopeless, like pouring water into the ocean… or trying to get a parrot to stop talking and start thinking.