By J. MICHAEL BASS
We have been the victims of conventional wisdom since the beginning of time. The earth is not flat. Bloodletting is not a valid medical treatment. A human being can run a mile faster than 4 minutes. Elvis really is dead! Let’s just say, conventional wisdom is often wrong. A very wise man once asked me, “If what you know to be true, turns out not to be true, when do you want to know it?
This issue can be even more compelling when it comes to our personal financial picture. Stephen Covey, in his book, The 7 Habits of Highly Effective People, pointed out we can get caught up in climbing the ladder of success only to discover it’s leaning against the wrong wall. You’re only going to retire once; you think you might want to get it right?
The following statements represent some of the conventional wisdom of the day concerning financial matters. But are they true?
Picking the best investments will make you wealthy.
Too many people believe the path to riches is finding the best investments. This is wrong on so many levels. First, it ignores what you’re doing with the rest of your money. What if you’re making mistakes in how you pay your taxes; making major purchases like cars, college educations, and weddings; saving for retirement; selecting the right insurances; handle debt; etc.? The truth is making better decisions with your money is the path to riches. When you make poor financial decisions, you put more pressure on your investments to make up the difference. This can cause you to take too much risk.
Speaking of risk, this is the most overlooked factor of selecting investments or an investment strategy. Looking at return without considering the risk is like driving a car without brakes! The risk/return tradeoff is imperative. If you can’t stand the risk, you will sell out too soon and not be around to enjoy the return.
The fact of the matter is investments are not good or bad. They’re like tools. You use the one that fits its intended purpose. To do that you need an investment strategy that works. Most people don’t even have an investment strategy, and if they do, they are likely to abandon it when it looks like it’s not working.
The point is, trying to pick the winners is not the answer to growing your wealth!
Pay your house off as soon as possible! Pay cash for everything!
The problem is, most people think if they owe money they are in debt. There is a difference between debt and leverage. Debt is when you owe money you can’t pay back. Leverage is when you choose to borrow money to pay for something even though you have the money to pay for it.
There are a couple of issues here. First, paying your house off gets you nothing. Equity does not grow. Real estate appreciates whether the house is debt free or mortgaged to the hilt. Therefore, the equity you have in your house earns nothing. It’s dead money!
Second, there is no such thing as paying cash. What you’re really doing is self-financing. When you take money out of an investment to pay for something, you not only lose that money forever, but you also lose the growth on that money. Even if you pay yourself back, you will never make up for the money you lost.
A couple of caveats here. You must have an arbitrage between your borrowing rate and your investment rate. And you can make the payments without interrupting the funding of your investments. If you can’t do that, you can’t afford it.
You’ll pay less taxes in retirement.
Sorry to disappoint you, but the only way this one is true is if you’re living off Social Security. One of the many reasons you will pay more taxes in retirement is you deferred the taxes on most if not all your retirement savings. Remember 401(k)s and IRAs? You did not defer it, you just postponed it. In retirement, when you have little or no ability to control your income, you will be paying 100 percent ordinary income tax on every dollar. Oh, and you get to pay taxes on up to 85 percent of your Social Security. Not to mention you may get the privilege of paying extra for your Medicare.
Net worth is a measurement of wealth.
Who came up with this one? Your net worth statement is nothing more than a point in time estimate of what your assets are worth. It’s really a personal balance sheet. Ask any business owner if they use their balance sheet to run their business? Of course not! They use their Profit and Loss statement and manage cash flow. Remember this, assets that cannot be converted to cash or cash flow when you need it are worthless. The dirty little secret in the financial services industry is they do not know how to create sustainable cash flow when you need it. The main reason is they cannot figure out how to get paid to do it. Here’s a novel idea, if what you want in retirement is cash flow, why don’t you plan for that in the beginning?
Revenue – Expenses = Profit
This one actually is true! Unfortunately, it leads one to believe profits are what fall out after everything else has been accounted for. What’s worse when you do make a profit have you ever wondered where it went? I’m reminded of the old Wendy’s commercial, “Where’s the beef?” So, where’s the cash? A simple adjustment to the formula produces a dramatically different outcome. Revenue - Profit = Expenses. Many of us learned this principle when we were children with our piggy bank. Pay yourself first! So, it turns out your mother may have been the best business coach you ever had.
We just wanted you to know there is a better way.
- Michael Bass, CFP®, CIMA®, is the President and CEO of PrimeQuest Wealth Strategies in Altamonte Springs, FL. He has over 30 years’ experience helping business owners and professionals learn to make better decisions with their money so they can achieve financial independence. Visit https://primequestwealth.com