Myths, the late Joseph Campbell taught us, are fundamental truths that help people carve order out of chaos. But in personal finance, myths are often fundamentally false. Yet, most of us cling for years to financial misconceptions, fantasies and half-truths, merrily unaware that they're, well, myths.
To help shine the light of truth on some financial fictions, staffers at USA TODAY selected 10 of the most common myths about personal finance. We explain why each is untrue. And for each myth, we reveal the reality and suggest a better path to financial security.
Myth: The more I know about investments, the less likely I am to fall for scams.
Reality:A study by Wise & Healthy Aging, funded by the Finra Investor Education Foundation, found the opposite was true for investors 60 and older who fell prey to fraud. Victims tended to be more financially literate than non-victims. Why? Possibly because victims are often knowledgeable enough to feel confident about investing — but not enough to detect inappropriate products or outright scams, says Grace Cheng Braun, chief executive of Wise & Healthy Aging.
While no research is available for investors of other ages, the same pattern likely holds true, since a little investment knowledge tends to lull many people into overconfidence about their investment know-how, Braun says. Investors should check with state and federal regulators about the legitimacy of an adviser or financial product before investing.
Myth: Your fund's performance is the main factor in the growth of a retirement account.
Reality:Not so. And your fund's performance is the one factor over which you have the least control. The best way to increase your retirement kitty is more elementary: Save more.
Let's say you earn $50,000 a year and save 5% of your salary annually. Each year, you get a 4% raise. If your fund earns 10% a year, you'll have $651,000 in 30 years. Sure, stocks have typically earned 10% or more a year in the very long term. But the long term includes vast stretches of poor performance. If you really need $651,000 to retire, you shouldn't bank on a 10% annual return.
Better to assume a smaller return and save more. Say you earn the same pay, but this time save 10% of it. Your fund, alas, earns just 6% a year. Yet, after 30 years, you'll have generated $663,000. And if your fund really does earn 10% a year, you'll have $1.3 million.
Set savings goals rather than trying to pick the next hot fund, says Dan Makin, financial advisor for the Professional Planning Group in Westerly, R.I. "If you pick the wrong fund, you can get really hurt."
Myth: Dollar-cost averaging boosts returns.
Reality:There's certainly nothing wrong with dollar-cost averaging; it involves investing an identical amount into a mutual fund at regular intervals. But that strategy won't necessarily deliver superior returns in the long run.
With dollar-cost averaging, you'll automatically buy more shares when a fund's share price is low and fewer when the share price is high. That serves you well.
But the stock market rises more often than it falls. If you have a lump sum to invest, you'll generally earn more money if you invest the entire amount at the beginning of a period, rather than bit by bit.
Say you had $12,000 in 1998 and invested the entire sum in the Vanguard Total Stock Market Index fund. After 10 years, you'd have $16,775 in your account, according to Morningstar, the fund trackers. Had you invested incrementally in the same fund — say, $100 a month for 10 years — you'd end up with only $12,350.
In some cases, you'll earn more by dollar-cost averaging. If, say, the period begins with a soul-searing bear market, your returns improve by investing a bit at a time. But don't dollar-cost average to try to improve your returns. Do it because it's the easiest way to save on a budget.
Myth: I should always get the credit card with the lowest interest rate I can find.
Reality:If you pay off your balance in full every month — about half of us do — it generally doesn't matter what rate applies to the card. Shop instead for cards with no annual fee and generous rewards. Also pay attention to late, over-the-limit and foreign-exchange fees. Through the years, banks have made it all too easy for such fees to snag even the most financially prudent credit card users.
If you do carry a balance, look for a low-rate card on such sites as Bankrate.com, CardRatings.com and LowCards.com. Just be sure to look beyond the teaser rate, which will likely jump after three to six months. And don't even think about a rewards card.
"In general, rates on rewards cards are about 2 percentage points higher than on other cards, so you're going to pay more in interest charges than you're actually getting in rewards" if you don't pay your balance off each month, says Justin McHenry of IndexCreditCards.com.
Myth: If you file for personal bankruptcy, you'll lose your home.
Reality:"In most cases, people can keep their home in bankruptcy, especially when they don't have much equity," says Henry Sommer of the National Association of Consumer Bankruptcy Attorneys.
But state laws vary, so homeowners should look into their own state's rules. Those with little home equity might be able to keep their home if they file for Chapter 7 bankruptcy, which erases most debts but typically requires you to pay overdue mortgage bills upon filing. Another option: Chapter 13 bankruptcy, which usually entails a debt-repayment plan that lets you pay past-due mortgage bills over time.
Myth: Buying a house is always better than renting.
Reality:Many investors jumped on this bandwagon during the housing boom, feeling they'd been tossing money away and forgoing a tax break by renting. But sinking home prices have made many homeowners regret their hasty purchases.
Here's when it makes sense to rent: Your budget won't accommodate extra home-buying costs, such as property insurance and taxes. You can't accept the idea that if the toilet overflows, you — not a landlord — will have to pay to fix it. Or you don't expect to stay in the house at least five years.
"The transaction costs of getting into a home and then ultimately selling a home are exorbitant," says Keith Gumbinger of HSH Associates, a consumer-loan information site. "If you're only going to be there for two years, (the purchase) could be a money-loser."
Calculators on HSH.com, Bankrate.com and other sites can help you weigh whether now's the time for you to buy. If the answer is yes? Good luck. Even as homes have become more affordable — thanks to falling prices and lower rates — lenders have made it harder to buy one. Today, you'll need higher credit scores and larger down payments to qualify for a loan.
Myth: Because I'm getting a tax rebate this year, my 2008 tax bill will be higher.
Reality:No, it won't.
Starting next month, more than 130 million taxpayers, senior citizens and disabled veterans will receive rebates ranging from $300 to $600, or $1,200 for married couples who file jointly. Parents with dependent children under age 17 will be eligible for an additional $300 per child.
Technically, the rebate is a credit based on your 2008 taxes. To get money into consumers' wallets more quickly, though, Congress decided to calculate the rebate using taxpayers' 2007 returns, says Mel Schwarz of the accounting firm Grant Thornton.
If it turns out you're due a larger credit, you can claim it when you file your 2008 tax return. And if your rebate was too large? No worries: You won't have to give the money back.
Surveys suggest that taxpayers will be more likely to save their rebate or use it to trim debt than to spend it. But whatever you do with the money, don't worry about setting aside a portion of your check for the IRS. The rebate won't be treated as income when you file your 2008 return, Schwarz says.
Myth: E-filing your taxes makes it more likely you'll be audited.
Reality:Taxpayers have an equal chance of being audited whether they file a paper or electronic return, says Robert Marvin, a spokesman for the IRS.
In fact, e-filing could reduce your chance of an audit. Those who use tax software to prepare and file their returns tend to make fewer errors than paper filers, the IRS says. Paper filers are more likely to omit information, too. And when you leave stuff out of your return, you're more likely to draw scrutiny from the IRS.
SAVING FOR COLLEGE
Myth: I put myself through college by working part time and taking out loans. So can my kids.
Reality:College costs have risen at a much faster rate than inflation. Financial aid has declined. And wages from part-time jobs don't go as far now.
In 1981, you could work full time all summer at minimum wage and earn about two-thirds of annual college costs, an analysis by Heather Boushey, economist for the Center for Economic and Policy Research, found. Today, a student earning minimum wage would have to work full time for a year to afford one year at a four-year public university.
The Pell grant, the largest source of direct federal aid, hasn't kept up with costs. In 1986-87, the maximum Pell grant covered about 52% of the average cost of tuition, fees, room and board at a state four-year college or university, according to the College Board. In 2006-07, it covered only 32% of the cost.
That means students are increasingly relying on loans to fill the gaps. Yet, there are limits to how much in federal loans you can borrow. As a result, students at high-cost schools have had to increase their reliance on private loans, even as the credit crisis has made those loans more expensive. And borrowers who don't have a co-signer with excellent credit might not be able to get a private loan at all. (Student loan safety net, 2B).
The upshot? Two-thirds of undergrads leave school with debt; the average debt for graduating seniors is nearly $20,000. Ten percent of undergrads are leaving college with debt of $35,000 or more.
Consider setting up a 529 college savings plan. Nearly every state offers a plan; many let you start with as little as $50. Some offer a state tax deduction. If you start saving when your kids are young, you'll likely amass a sizable sum by the time they start college.
Myth: I don't need to save that much for retirement, since my living costs will fall a lot once I stop working.
Reality:Most retirees don't spend less in retirement, says Sheryl Garrett, founder of Garrett Planning Network, a network of fee-only financial planners. She tells clients to expect to spend more, particularly during the early years of their retirement. "It's not uncommon for us to add maybe $5,000 to $10,000 to their yearly budget for trips, hobbies or other things they haven't had the opportunity to do," she says.
Even if you're determined to forgo travel, health clubs and restaurant meals, medical costs could drive a hole through your budget. Fidelity Investments estimates that a 65-year-old couple who retire this year will need $225,000 for health care expenses not covered by Medicare. Only about a third of workers expect to have employment-based health coverage during retirement, the Employee Research Benefit Institute's annual retirement confidence survey found. That's down from 42% in 2007.
Her advice: Save as much as you can. And ignore retirement-planning calculators that suggest you can live large on just 70% of your pre-retirement income.