Over the next several columns, I would like to explore with you four commonly held financial fallacies that will ruin your financial future. Previously, I shared some devastating statistics about the poor odds for being able to retire successfully without become completely dependent on either Social Security and/or your children.
Unfortunately, things are not working out for most people financially when they retire, as they thought they would. Therefore, the question has to be asked, “What’s responsible for so much financial failure?”
I believe the answer is that most people are following financial principals and philosophies that where once very sound, but today actually destroy your chances for a secure financial future.
It is a fact in this country, that we do not receive a single course, in either high school or college that teaches us the principals of personal financial management. We are trained quite adequately on how to be productive people and how to earn good wages, but we are not taught anything at all about how to properly design a college education program to insure our kids can go to college, or how to develop our own retirement plan, so that we might one day experience financial independence.
It all boils down to one simple fact: Those who achieve financial independence have become trained in the science of Personal Financial Management, and those who fail, usually have not.
Therefore, let us explore the four financial fallacies that are most responsible for ruining peoples’ financial futures. This way you, too, can learn more about this critical science called Personal Financial Management.
Fallacy No. 1: The safest place to keep your money is in a savings account.
Let me show you why this fallacy causes so much financial failure. People who are untrained in the science of Personal Financial Management usually think that what their investment pays them each year is their investment’s yield. For example, if we put $10,000 in a savings account for one year and it earned $200 in interest, most people calculate that to be a 2 percent return.
Now, that 2 percent assumed yield would be correct if your money lived in a vacuum. However, unfortunately we live in a world with many factors that directly affect our investment’s yield. The two most obvious that have the biggest impact are inflation and income taxes.
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For example, let us go back to our $10,000 savings example where we earned the $200 in interest. The first thing that happens any time we earn money is that our partner Uncle Sam comes forward and claims his share. Assume you were in the 28 percent tax bracket on the last dollars you earned. This would mean that you will have to pay $56 of your $200 in interest to the government in taxes, leaving you only $144.
The next factor that always affects our financial environment is inflation. Money has a direct value that corresponds to the year you actually spend it. To prove this concept, let me ask you to ask yourself a question.
Would you rather have your current paycheck to spend this month; or would you rather have had the same size paycheck back in 1931, during the Great Depression? Sure, 1931; it would have bought a hundred times more back then.
So the problem is that the dollar you gave the banker last year when you put your money into the savings account will buy less than the dollars the banker gives you back today because of inflation. In other words, let us say a dollar bought 100 slices of bread last year. If we had 2 percent inflation during the year, while your dollar stayed in your savings account, then the dollar you take out a year later will now only buys 98 slices of bread. That means you actually lost two slices of bread during the year while your money sat in the savings account. That is a true loss of 2 percent.
In our $10,000 savings account example, a 2 percent loss to inflation equates to a real loss of $200.
So, let us now add it all up.
We started with $10,000 in savings, which earned $200, making our new saving’s balance $10,200. But then we had to pay $56 in taxes, which reduces the balance to $10,144. Then inflation came along and caused us to lose another $200, leaving us a new balance of only $9,944.
That means that our original $10,000, after all its growth, is now $9,944, or, we lost $56. In other words, we took one-step forward and more than a step backward.
Therefore, while the financially untrained person believes he or she earned 2 percent; the more knowledgeable person realizes that inflation and taxes ate up all of the $200 in interest, plus $56 more of our original $10,000 principal balance.
More importantly, this example is using the lowest interest and inflation rates we have seen in decades. As interest and inflation increase, which they are currently doing, this impact of both will magnifies the net loss significantly.
Unfortunately, it is a fact that any money kept in a savings account during any period for the last 50 years lost money. In addition, what is even sadder is many financially untrained people, who pride themselves as being very conservative, keep their money in savings accounts because they are afraid to lose it.
Now please ask yourself, “How conservative is it to make an investment that guarantees a loss of your principal, with absolutely no chance for any financial gain?” Unfortunately, as this example proves, that is exactly what you get when you keep your money in a savings account.
My next column will explore Financial Fallacy No. 2: Pay off all your debt as soon as you can.