The Biggest Things People Get Wrong About Money

Financial Literacy The biggest things people get wrong about money

I’ve gotten to a point in my career where I’m commonly referred to as a financial “expert”. I’ve worked hard to broaden my knowledge and fill in the gaps, so I feel pretty comfortable in that role. When a friend or colleague asks me for advice, chances are I can help them in some way. 

But the more I learn, the more I realize how ignorant I actually am. Money is such a diverse and dynamic topic that it’s impossible to know everything, and even the most basic fundamentals can change over time. The best you can do is keep an open mind and actively challenge your assumptions. 

We all get things wrong about money. Here are some of the most common – and most dangerous – misconceptions. 

“Keep 30% balance on your credit cards.

I’ll never forget this argument I had with my friend Chelsea. We were talking about credit card rewards programs and how awesome they are. “Of course, you should never hold a balance on them, no matter what kind of cash-back you’re getting,” I told her. She disagreed, saying that you should always carry a small balance on your card or you won’t build any credit. 

In my opinion, this is probably the most persistent credit myth still making the rounds in 2019. It’s true that you need to have a balance on a card when the statement closes. That balance will then be reported to the credit card bureaus, but once the statement closes, you can pay off the entire amount without hurting your credit. If you pay off the balance before the statement closes then the card provider will report your balance as $0.  

An easy way to set this up is to create automatic payments that will go in effect after the statement closes, but before your due date. Go to your credit card account and click on the payments section. Then, create automatic payments for the full statement balance and choose a withdrawal date on or before your due date.  

“Investing is the same thing as gambling.”

When I was in middle school, the dot-com crash happened. I don’t remember much about it, except for the fact that a lot of people lost a lot of money. A year later, 9/11 happened and the market tanked again. When I was a freshman in college, the housing market crashed and the Great Recession began. 

All these experiences probably would have scared me away from investing, but my parents explained that a market crash doesn’t mean investing is bad. They told me about all the times their retirement accounts had faltered, only to recover and grow over time.  

Some people equate investing to gambling, that it’s all a matter of luck or secret insider knowledge. Fortunately, investing can be simple – and profitable – if you stick to tried-and-true methods.  

One of the best ways to invest and save for retirement is with index funds. In 2017, legendary investor Warren Buffett won a 10-year bet against a hedge fund manager, wagering that money invested in an index fund would outearn the manager’s picks. He earned 7.1% during that decade, while the hedge fund manager earned 2.2%. 

“You need a lot of money to invest.”

Many young people decide to wait until they’re older and earning a lot of money before they worry about investing for retirement. Unfortunately, this is one of the costliest financial myths. The longer you wait to start investing, the more you miss out on the magic of compound interest. 

A 22year-old who starts investing right after college will have $3,591.60 after five years if they save $50 a month. If they decide to ramp up their savings to $150 a month at age 27, they’ll have $456,081.29 in 40 years. 

Let’s compare that to someone who didn’t start investing until age 27. If they invest $150 a month for 40 years, they’ll only have $397,034.55 when they retire. That’s more than $50,000 less. 

The power of compound interest is about time more than money, so don’t worry that much about how much you can afford to contribute. Just get started as soon as possible. 

“A tax refund is always good.”

Every spring, millions of people file their taxes and get ecstatic when they discover a tax refund is coming their way. The average direct deposit tax refund last tax season was over $3,000.

Tax refunds may sound like bonus money, but refunds can stem from a couple of sources:

  • Refundable Tax Credits (Such as, Child Tax Credit-(CTC), Earned Income tax Credit –(EITC) or American Opportunity Tax Credit-(AOTC)
  • Tax deductions like student loan interest, the standard deduction, and itemized deduction that lower your taxable income
  • Excess Tax withholding from Paycheck

If your tax refund is because of the third reason pointed out then, it means you had the government withhold too much from your paycheck. In essence, you’ve just given the federal government an interest-free loan.

If you have too much withheld from your paycheck, you may miss out on having that money in your pocket to help your financial situation. Most Americans use a tax refund to pay off debt, but getting a huge lump sum at tax time can actually mean they end up paying more in interest during the year when waiting for your tax refund to pay down debt.

Here’s how it works: Let’s say you have a $2,000 credit card balance with 24% interest. You can only afford to make the minimum payment, which barely scratches the surface. When you get a $2,000 tax refund, you put the whole thing toward your balance. This wipes out your debt completely, so you no longer have credit card debt. Great, right?

Wrong. If you didn’t over withhold taxes, you would have more money in your pocket during the year and would have paid down your credit card debt slowly over time. This would save you more money on interest rather than waiting until you got a tax refund.

Whether you adjust your withholding allowances to get a bigger paycheck or a bigger tax refund depends on your personal preference. Some people may opt for more money in their paycheck, but end up spending it on lattes and shopping whereas taxpayers who prefer a tax refund to pay down debt use over withholding as a forced savings mechanism. One important thing to also consider is how new tax laws impacted your tax situation and your overall tax picture so whether you prefer a bigger paycheck or a bigger tax refund, it is important to adjust your withholding every year. You can also use the TurboTax W-4 withholding calculator to easily figure out your personal withholding allowances and give your W-4 form to your employer.

 

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Comments (20) Leave your comment

  1. I’m glad you clarified the tax refund issue. I get a refund but not because my withholdibg is too high. Rather, its from the tax credits. I don’t qualify for many anymore, but many people say that if you get a refund then you’re giving the gov’t free money. Thanks for the clarification.

    1. True to a point, if you owe money, you have to pay interest on that money. Its a fine balancing act to try to get a refund of a couple hundred, but not a couple thousand. With the new tax laws I messed it up this year.

    2. Very good article debunking some dumb ideas that won’t die, but one small missed opportunity and a distinction between categories that does not necessarily make sense. The author seems to imply (or gives life to the assumption that) people who receive refundable tax credits and people who over-withhold income tax from their paychecks are separate and distinct groups of people.

      It’s true that some people get a refund because their combined refundable tax credits are higher than their tax liability for the year, i.e. they have a “negative” income tax bill. In that (relatively rare) instance, that person can and should still adjust their withholding to make sure that $0 are withheld from the paycheck.

      My family receives a Mortgage Credit Certificate (max $2,000/year credit), a few Child Tax Credits, and the Child/Dependent Care Credit. I’m blessed to have very smart and helpful colleagues in our Payroll Department, who helped me adjust the personal allowances on my W4 to ensure that I did not over-withhold. In other words, anyone could benefit from taking a close look at their tax credits and essentially convert them into personal allowances to ensure they limit the amount of that 0% loan to Uncle Sam. Hope that makes sense.

  2. This article was insightful. Very informative. I recommend reading it twice at least. Saving money is difficult when you’re in your 20’s or 30’s but well worth it.

  3. I also get my refund from refundable credits, as I have asked to have ZERO withheld throughout the year. (Which explains the problem with our tax system).
    But you incorrectly listed tax-deductions as a source of a tax-refund. You correctly stated: they reduce your taxable income. That reduces the taxes owed, which increases your refund (if you’re getting one) from the other two sources: refundable credits or paycheck withholding.
    If a person gets no refundable credits and has nothing withheld, they cannot get a refund from deductions, even if they have enough to get their taxable income to zero (or below).

  4. Your point about over-withholding is fair. But to take it a step further, it’s so hard to know if the amount you are withholding is the “right” amount. It’s like stabbing in the dark. I’ve put 0-0 on my W-4 and still owed money before. The problem is with the system. They need to come up with a way for people to break even without using guesswork. It’s time.

    1. The IRS has a tax withholding calculator on their website to help determine if you’re withholding too much/too little. I used it a couple of times throughout this past year (because of the tax reform) to make sure I was on the right track. It’s just an estimate based on the information you input; but, it ended up being pretty accurate for me when it came time to file.

  5. When I read ” you need little money to invest” I asked myself “what do I invest in and how much then”?

    1. A total US stock market index fund, and as much as possible as often as possible. Ignore temporary fluctuations and never sell. Vanguard has a good one (VTI or VTSAX) as well as Fidelity (FZROX).

    2. Clint, look into Mutual Funds fitting the your risk tolerance, then consider dollar cost averaging. Do not be concerned with fund per share price fluctuations; it will go up and down. As for down keep in mind as it decreases, using dollar cost averaging, you are purchasing more shares with the same monthly dollar amount. Keep in mind you are in it for the long haul.

      Of course folks say the market is too volatile. The market is similar to someone going up stairs with a yo-yo. As you climb the stairs the yo-yo is going up and down but the overall trend is up. Look at the NYSE, DOW, NASDAQ, and the like, over the past ten decades and more there have been many up and downs yet the overall trend has definitely been up.

      Hope that helps you.

      Cordially,
      RicD

      1. RicD, your yo-yo on the stairs analogy is spot on, and I plan to use it the next time this topic comes up! I have a friend who sold all of his AT&T stock in 2008 because he got scared. He was upset over the money he lost when he sold and again over the gains he missed out on when the market returned and surpassed its previous value. Investing is like gambling only if you behave like a day trader.

        Clint, I second the advice Joey & RicD have given. Index or mutual funds are the easiest way to ensure diversity in your portfolio. I would also add that you find a friend or financial adviser you can trust to help you navigate the terminology and SHOW you how to decide what’s best for you. The better you are at reading and understanding all of the terms and numbers on an investment list, the easier it will be to choose the investment options that are best for you. Good luck!

      2. Mutual funds tend to cost more in expense fees than comparable index funds and rarely outperform them — more often, they underperform the underlying index because as pointed out in Warren Buffet’s bet (see: article), very few fund managers are capable of beating the market itself.

    3. Low fee index funds. Vanguard has some of the biggest and lowest fees for relatively passive investors (set it and forget it types). You can check out their minimum investments on their website. You can open and account online and they have lots of investor education about balancing your portfolio, no matter the size. The important thing is to start as soon as you can to take advantage of the compound interest.

  6. I agree 100% with all you said, glad you affirm my thinking is right. I don’t have auto payments for my credit cards because I don’t like auto payments, we may disagree there. I do pay them after the closing date and before the due date. Good info

  7. Telling people to have a balance when their credit cards close is silly and just plain wrong. There isnt anything wrong w reporting a zero balance. A lot of credit cards, Amex for example, if you don’t pay your last months balance off by the due date, not the closing date, the due date, you lose your grace period until paid in full. Then you’re paying interest on everything you buy starting day one. The whole carry a balance thing is all a myth!!! Carrying a balance is fine, but you’re not “ not” building credit if your card reports zero as long as the last months balance is paid in full. Best advice is…. if you can’t afford it, don’t buy it. If you can’t pay it off by the end of the next month don’t buy it. It’s moronic to buy something you cannot afford then pay 20% interest on it to boot. It’s why most struggle. That, and stop eating so many meals out!

  8. Your first tip regarding credit cards is just SILLY. The best way to avoid getting into financial trouble with credit cards is to NOT USE THEM AT ALL.

    The biggest financial mistake I ever made in my life was the day I went to orientation as an incoming college Freshman, and right outside the building was a table set up by a credit card vendor. As a poor starving college student I felt special because the credit card company though I was “worthy” enough to give me a $1,000 line of credit. It all went downhill from there… and 20+ years later, I can tell you that I would be in a much better situation financially if I had never started down the path of borrowing money on credit cards.

    Your other 3 points, regarding investing and tax refunds, are good advice. Start investing in retirement early, and you’ll be wealthy going into retirement. The fastest way to get rich is to get rich SLOWLY… in the tortoise vs. the hare race, the tortoise wins every time.

    … and if you don’t have a credit card payment to deal with each month, that money can be invested and take advantage of the beauty of compounding growth (unlike credit cards, in which interest is compounding in the wrong direction).

  9. Another issue I feel is for those who are self employed. It really makes a difference when you spend the money on a really good accountant to tell you things you need to do when it comes to your taxes.

  10. Good article. Although I over withhold my taxes on purpose to get a nice refund every year, but I actually use that money refunded to fund my yearly ROTH IRA contribution. This has been very beneficial for me.

    1. Question Michael: Wouldn’t you make more by lowering the amount of taxes that are taken out of your check and depositing the extra money each month into the ROTH IRA, due to compounding interest, etc? Is it too much of a burden to contribute to a ROTH IRA monthly or is there limit of how many payments can be made per year? Just curious.

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