Financial Fallacies- Part 1

Article orginally appeared in September 2008 issue of Southern Neighbor newspaper, Chapel Hill, NC


By Todd Washburn, CFP^®

One of the great joys of being a Life Planner is hearing all the wonderful goals clients have.  I love it.  But as much as financial planners love to hear client goals, ask them about the excuses they’ve heard for not doing some basic financial strategies and will you get an earful.  We hear them time and again.  In this and my next article I want to highlight some of these common fallacies and why they’re so dangerous. 

Fallacy #1:  We don’t need an emergency fund

            I often recommend putting enough money for 3-6 months of living expenses into a money market account, in case of job loss or other unexpected expense.  But some people won’t do it.  They say they don’t want such low returns and instead will tap other assets.  But what could they tap?  I’ve heard:  other investments, home-equity line, 401(k)s, and even family.  Under some circumstances these might be fine.  But we’re looking at worst-case scenarios- like a very bad economy.  How would they work then?  Well, you’d be selling investments after they’ve already dropped.  Selling low rather than high.  Home-equity lines are still possible, if you already have one.  But we’re seeing cases where lenders are freezing equity lines because the house value has decreased.  Borrowing from 401(k) plans is easy, though not without strings.  First, you have 5 years to pay the money back, unless you lose your job.  At that point it’s all due immediately, or you’re subject to taxes on the loan and a 10% early-withdrawal penalty.  And you can’t ever put the money back in because it’s become a withdrawal, not a loan.  As for family, they may be hurting too and unable to help.  Plus, do you really want your parents or in-laws involved in your finances?  Bottom-line, keep it simple and save the money. 

Fallacy #2:  “My wife will just go back to work”  

            I’m not being sexist.  It’s just that I usually hear this from the husband.  The household might be:  young couple, a couple of children, wife is home raising them, husband makes good money and they spend most of what they earn.  It’s been recommended they buy a policy on him.  What I hear from him is that they don’t need such a large policy since she could just go back to work. What are some of the questions I ask at this point?  Is her training/certification current?  How long would it take for her to find work?  How much can she earn relative to what he makes?  Who will care for the kids- and how will that be paid for?  Will the family have to move to a less expensive area- likely changing schools, losing friends and neighbors?  The answer is to buy the insurance.  If the surviving spouse can return to work, it’s a bonus.  But he/she doesn’t have to do it right away.

Fallacy #3:  I have enough life insurance from my employer

            This crops up when an employer provides insurance equal to 4-5 times their salary.  Why buy more when you have that?  I have 3 comments.  While 4-5 times salary may seem like a lot, it probably isn’t when it must replace take-home income and retirement savings.  Second, if you leave your employer you’ll likely lose your insurance and be uninsured until your new job starts.  And finally, those “group” rates often aren’t that cheap.  Many times a healthy individual will pay less for private coverage.  The group policy must accept everyone and the rates reflect that.   Employer-provided life insurance is nice, but it’s rarely the end of the story.

Fallacy #4:  My employer’s disability insurance is enough

            Many larger employers provide disability insurance (DI) to their employees.  After 90 days it might pay 60% of the insured’s pay for 2 years if he can’t do his specific job, and after that to age 65 if he can’t do any similar work.  Now, 60% of pay is probably close to what comes home each month.  So that’s fine, right?  Probably not.  The 60% is usually of base pay, not including commission or bonus income.  After 2 years you might have to work in “any” occupation deemed appropriate to receive even partial payments.  Who knows what that will be?  The biggest problem though involves taxes.  If an employer pays the premiums, the benefits are fully taxable.  You’ll receive 60% minus taxes.  It’ll be a lot less than 60%. So what can you do?  While you usually can’t decline the employer’s policy- it’s part of your benefits- insurance companies will build off of that, accounting for the taxes owed and perhaps adding other benefits.  Any benefits for which you paid the premiums are tax free. DI is not inexpensive but the benefits can be huge benefit.  Younger workers are more likely to become disabled than to die, with dire consequences.  Income stops, employer benefits may stop, and contributions to retirement accounts stop.  

            I call these “fallacies” because they are false reasons which stop us from doing things we should do.   Insurance and savings plans aren’t sexy.  You can’t play with them.  But they’re important to a secure foundation 

            Next time I’ll talk about a few more fallacies, including the Granddaddy of them all.  Care to guess?