Financial Planning for Dummies – OpEd – Eurasia Review
Most people are really bad at personal financial planning. Among the mistakes: they save too little or they save too much; they buy the wrong amount of life insurance; they leave large sums of social security benefits on the table; they pay more taxes than they should, etc.
The people who make these mistakes are not just ordinary people. They include highly educated and sophisticated people, including virtually all Wall Street economists and analysts. They almost certainly include you, the reader.
So why are so many people getting so many things wrong? Because financial planning is very, very complicated. To take just one example, Social Security has 2,728 rules governing 13 benefits. And the agency is ruthless. It does not reimburse you once you find out about past mistakes.
Because financial planning is so difficult, most people make very important decisions without knowing the true costs of their choices. Getting married, divorced, deciding to have another child, quitting work to go back to school, take early retirement, etc. These are not small decisions.
Fortunately, help is at hand. Boston University professor Laurence Kotlikoff has written Money Magic, a must-read book that has valuable information for just about everyone. The book itself reviews the main mistakes people make when limiting their income, raising their taxes, or putting them at unnecessary risk.
Take social security. Americans leave billions of dollars on the table every year because they do not claim benefits in the most beneficial way. Kotlikoff says it is a “use it or lose it” system. If you do not formally request a benefit to which you are entitled, you will not get it.
People sacrifice billions more, not because of mistakes, but because they don’t make smart choices. For example, unless you are terminally ill, it is almost always a bad idea to claim early Social Security benefits. If you wait until age 70, you will miss out on 8 years of benefit checks. But Social Security more than makes up for this by increasing your monthly benefit amount by 8% for each year you are late.
Basically, 5% of this increase compensates for years without benefits, and the remaining 3% can be seen as a real return on your “Social Security wealth”. Where else can you find an asset that earns a real risk-free rate of return of 3%?
Whenever possible, advises Kotlikoff, live off withdrawals from your IRA or 401 (k) account and let your Social Security account grow.
Another costly item in the financial life of most people is housing. In fact, the average family spends 25% of their disposable income on it.
Most people think of the cost of housing as their mortgage payment. But that’s wrong, says Kotlikoff. The price of your house is the price you pay for it. If you take out a mortgage, this is a separate decision, and you should avoid it if possible. “Mortgages are not your friends,” he wrote. “They are fiscal and financial losers, [so] reimburse them as quickly as possible.
Here’s why. The interest rate on a typical 30-year mortgage is more than double the rate on 30-year government bonds. Both prices are fixed. So if you take out a big mortgage so that you can invest in financial assets, you are losing money.
What about maintaining a mortgage to be able to invest in the stock market? In the long run, stocks pay more than bonds. But that’s because they are riskier. After adjusting for risk, the rate of return is the same. “Hold a mortgage. . . whereas investing at risk is borrowing in order to gamble, ”he wrote.
But aren’t mortgage payments tax deductible? This use to be an attraction. The 2017 tax reform, however, increased the standard deduction so high that most households do not benefit from the mortgage deductions. Kotlikoff even encourages people to consider withdrawing money from a regular IRA or Roth IRA to pay off their mortgage.
So why own a house? Why not rent? It turns out that there is a tax advantage to home ownership. Take two identical people who own two identical houses. But instead of living in the house they own, each lives in the other’s house and pays market rent. Result: their rental income is taxed. But if everyone lives in their home, the rental value of the property is exempt from tax. It’s a tax benefit that you don’t get by owning another asset.
Then there is the student loan scandal. After mortgages, student loans totaling over $ 1.6 trillion are our largest form of debt. And that is risky debt. Two in five students drop out and never graduate. Those who graduate face an average debt of $ 33,000. Some owe more than $ 100,000. Parents are also racking up debt for their children in college, which now totals around $ 100 billion. In 2019, one in five borrowers were unable to pay what they owed.
A chapter by Kotlikoff on this issue is titled “Don’t Borrow for University, It’s Way Too Risky.” Every high school student goes to college, and every parent of those students should read this chapter and read it several times.
About 90 percent of student loans are federal government loans. If you cannot pay them back, you cannot discharge them through ordinary bankruptcy. The government can garnish your salary. He can seize part of your Social Security check. You may not be able to renew a professional license or enlist in the armed forces.
Kotlikoff criticizes the colleges for charging full freight of $ 80,000 per year for tuition, accommodation and board, or $ 320,000 over four years, and for luring participants with loans they call it “rewards”. He likens it to the sharecropping system prevalent in the post-war south, in which “the students borrowing for college are the sharecroppers and the landlords are Uncle Sam and his college fellows.”
There are many great suggestions on how parents can rearrange their financial portfolios to qualify for student aid (excluding loan), and some brilliant suggestions on how students can enroll in cheap colleges. and take online courses at elite schools like Harvard and Yale.
As a bonus, Kotlikoff invites you to take advantage of its online software package which sorts out all kinds of complicated problems that no human mind is able to master on its own.
If you don’t save more than the price of this book, there is something seriously wrong with you.
This article was also published in Forbes