Four money-management myths

April 1, 1998
Nothing is simple when it comes to managing your money. Faced with tricky financial decisions, many of us end up relying on the "wisdom" that is passed along by advisers, colleagues and friends. But much of that "wisdom" is simply not the best.

Hugh F. Doherty, DDS, CFP

Nothing is simple when it comes to managing your money. Faced with tricky financial decisions, many of us end up relying on the "wisdom" that is passed along by advisers, colleagues and friends. But much of that "wisdom" is simply not the best.

x- Myth #1 - Buy the largest house possible and take out the largest mortgage the bank will give you. In the 1970s and early 1980s, homes were a great investment. The bigger your house, the more you made when you sold it. Much of the gains that resulted came from a combination of high inflation and borrowed money. Suppose that in the 1970s you put down $20,000 as a down payment and financed a mortgage of $80,000 to buy a house valued at $100,000. Inflation rose more than 8 percent a year in the years that followed. Your new home also followed suit and rose in value to $160,000. Even if you never paid down any of your mortgage principal, your home equity would balloon from $20,000 to $80,000. Today, inflation is all but dead. The result of this means that home values won`t rise nearly as fast. Therefore, there is no longer the future "pot of gold" when it comes time to sell your house. In general, buying a large home today is not a good investment.

x- A better strategy: Rather than taking out a huge, 30-year mortgage to buy a big house, take out a smaller, 15-year mortgage and purchase a more modest home. You will be out of debt in just 15 years, which will free up some money that can be used to pay for either your children`s college education or fund your retirement on a personal basis.

x- Myth #2 - Keep three-to-six months` expenses in cash for emergency money. If your monthly expenses were $7,000 a month and you want an emergency reserve large enough to cover three-to-six months of living expenses, you will need to sock away about $21,000 to $42,000 into your "emergency fund." That is a lot of money.

x- A better strategy: Keep enough in a money market fund to cover one to one-and-a-half months` expenses. In the event that you need more for living expenses you could:

x- Use your investments as security to borrow the necessary money in the event that you are deficient

x- Establish a home-equity line of credit with your bank

x- Myth #3 - Cash-value life insurance is a great investment. Insurance agents say cash-value life insurance is the solution to all of your financial problems. They claim it will provide money for your children`s college education, protect your family if you die, reduce your income tax, help your retirement planning, bail you out in the event of an emergency, etc. Cash-value insurance can indeed do all of those things previously mentioned, but the only problem is, it does not do any of those things very well.

x- A better strategy: Life insurance is for protection, not for investment purposes. If you need life insurance, purchase low-cost term life insurance like that provided by the ADA. A term policy will give your family the same death benefit as a cash-value policy, but at a fraction of the cost.

x- Myth #4 - Put all of your retirement moneys in tax-sheltered savings vehicles. We often are advised to put every dollar possible into tax-sheltered savings vehicles such as IRAs, Qualified Plans, 401(k) Plans and Variable Annuities. Usually, that`s the right thing to do, but these vehicles also have some drawbacks. The biggest one is, you can`t pull money out of these accounts before age 591/2, except for special situations, without getting hit with a terrible combination of income tax and tax penalties. After 591/2, all withdrawals are taxed at income rates, rather than at the lower capital-gains rate. Even after death, all of the income taxes owed on your tax-sheltered accounts still have to be paid. Putting any money into variable annuities can be dangerous. Variable annuities are losers because of their hefty commission costs.

x- A better strategy: Instead of putting all of your retirement moneys into a tax-sheltered savings vehicle, which Uncle Sam has total control of, you should save and invest for future financial security on a personal basis. That way, you will be prepared if you have a financial emergency or want to retire before age 591/2.

Hugh F. Doherty, DDS, CFP, is a national lecturer, financial advisor to the health-care profession and CEO of Doctor`s Financial Network. For personal financial consultations or to have Dr. Doherty speak to your study club or dental society, call (800) 544-9653.

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