Financial Fallacies- Part 2
Article originally appeared in the October 2008 issue of Southern Neighbor newspaper, Chapel Hill, NC.
by Todd Washburn, CFP®
In the Financial Fallacies- Part 1 article I introduced the idea of Financial Fallacies. They are beliefs that can cause great financial harm. I’m not always sure the person really believes it, but rather uses it as an excuse not to act- perhaps for reasons of cost, complexity, or discomfort. Previously I discussed emergency funds and life and disability insurance. Here are four more, including the Granddaddy of them all.
Fallacy #5: We don’t need long-term care insurance
The reasons given are usually: too poor or too wealthy, never going to become infirm, or the kids will handle it. Let’s address the last two first. Even if the kids could help, they may resent having to use their retirement funds for their parent’s care. And care facilities are full of people who believed they wouldn’t need help.
Wealth certainly factors into the long-term care (LTC) decision. For the poor, their care will likely reside with Medicaid. For the middle-class, it’s not as clear-cut. The cost of insurance may be a stretch, but it can provide peace-of-mind. Care, even at home, can be expensive while some facilities only accept “self-pay” (no Medicaid) residents. If their money runs out they may have to move. The LTC coverage stretches assets and expands care options. People with significant personal wealth can afford to pay their own way. So they don’t need LTC insurance. But why not pass the risk to others? Premiums paid over 25 or 30 years can still be less than a couple of years in a nursing facility. And their children will rest easier knowing there is insurance if needed. Finally, it protects the estate, helping preserve the financial well-being of the spouse and any inheritances or charitable bequests.
Fallacy #6: I can do my Will myself
You see them on TV and the web- a Will-in-a-Box. It appeals to those who don’t want to pay an attorney. But it’s penny-wise, pound-foolish. Yes, the software is only $30 and “valid” in all 50 states. You can do it at home and you won’t have to pay an attorney- for now at least. There are some serious problems with this approach. The first is the likelihood that nothing will happen. An attorney will get and keep the process going while you probably won’t. Document quality is another concern. Estate laws vary by state. Different strategies may be applicable in each state. A competent attorney will know what works best in her state. I’m not convinced the software will do as well. My final concern is the estate plan itself. There can be difficult and complex decisions to be made. Is a trust needed? Should inheritances be equal or equitable? Who should be the children’s guardian? Most of us don’t think about these questions very often. While the software may raise them, an attorney has helped many others answer them. Since it can be expensive, or impossible, to undo a mistake after you die, please consult an attorney specializing in estate law.
Fallacy #7: I’m a risk-taker
Men seem more prone to this assessment than women- especially for investing. Either they don’t really understand the risk they’re taking, or they’ve convinced themselves they really can handle it. It’s especially prevalent during good economic times when investment returns are up and life is good. What they forget is that risk isn’t one-directional. Risk doesn’t just apply to the market going down. It also applies to it going up. But we like that risk. In fact it’s not seen as risk but as good luck or skill. But chasing higher returns exposes them to higher potential loses, losses that can be unaffordable. They learn a tough lesson too late- they’re not as risk-tolerant as they thought. Remember, risk and return are always linked. Chasing greater return means accepting greater risk. Don’t let greed or a false sense of skill convince you to take risks you can’t live with.
Fallacy #8: The Granddaddy of them all
This is it, the last fallacy. The one that can cause more harm than any of the others.
IT’S DIFFERENT THIS TIME
No, it’s not. It just seems so because it’s happening right now. It seems different because the “experts” say it is. It’s seems different because you’d like to believe it is as do so many others. Please reread Fallacy #7. Risk and return are forever linked. At best that balance is sometimes temporarily upset. But not for long. During the tech boom companies didn’t need products or profits, just an idea that sounded like it would make money. But eventually someone got spooked, started asking about profits, didn’t like the answers, and the bubble popped. While those in early may make money, you and I usually don’t hear about these things at that point. Then it becomes a case of not being the last one out. Right now there are people holding an extra condo in Florida that they were going to flip for a big profit- but the market decided it wasn’t different this time before they could sell it. I’m not saying things don’t ever change. They do, but rarely in ways leading to lots of people getting rich quick. Manias have happened for centuries, from tulip bulbs to housing prices. They all teach the same lesson- you won’t get rich being greedy. Understand the risk if everything doesn’t go perfectly. Don’t believe “it’s different this time”. It’s not.
There you have them, eight potentially costly financial fallacies. Yes, you might roll the dice and get lucky. But if Lady Luck turns against you it can be devastating. A large investment portfolio lost to premature death or disability, poor estate planning, or inappropriate investing/speculating doesn’t help anyone. Protect your downside and put things in order. When the worst happens you won’t be a victim of these financial fallacies.
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