"Inherited" financial advice could be very misleading

Sep 04, 2023

A lot of us carry various bits of "received wisdom" that work in our subconscious.

Unknowingly, we tend to be massively influenced by these “inherited biases”.

I decided to take stock of some of the other money lessons I grew up with. To what extent were they influenced by past--perhaps never to be repeated--history?

“Don’t buy used cars.”

In 2018, I was engaged in a Twitter discussion about cars.

Ben Carlson, director of institutional asset management for Ritholtz Wealth Management opined that spending on an expensive vehicle, SUVs, in particular, was likely hobbling retirement savings for many households.

I wholeheartedly agreed with that sentiment, and commented that many people are likely motivated to overspend on cars based on hubris. Cars are such an outward show of "how you’re doing," that people naturally want to make a good impression.

Bill Sweet, Ritholtz's chief financial officer, chimed in to say that buying a used car was a much savvier financial move than buying new. His central assertion is that cars are a depreciating asset, so you can greatly enhance the value of your car buy by waiting a few years. Let the fools pay up for the new-car smell; you reduce your lifetime ownership expense by buying a good-quality two-year old car.

But but but … wait, I thought. Don't used cars often have problems? Why would you want to take the risk of untold repairs when you could buy a new car and meticulously care for it? That's how my parents operated, and they weren't spendthrifts. I've never owned a used car, either. To the extent that we've had "used cars" in our family, it has been because one family member had driven a car for several years and then passed the old vehicle on to another, usually younger, family member who needed a serviceable, well-cared-for set of wheels.

But Sweet went on to argue that many people avoiding used cars may well be relying on outdated information. Car reliability has improved a lot over the past couple of decades, so buying a two-year-old car no longer means years of costly outlays. That stands in contrast to the 1970s and 1980s, when U.S. vehicles, in particular, experienced quality issues and Japanese vehicles won market share. People like my parents quite rationally avoided used cars; they also switched to foreign-made automobiles. And I, trusting them, followed their habits. My husband grew up with a similar mindset.

"Buy, don't rent."

While they never went so far as to say "Renting is like throwing money out the window," my parents--like many in their generation--were big believers in homeownership.

They adhered to the notion that if you planned to stay put, buying was better than renting. And a mortgage payment that seemed a stretch early in the life of a loan would seem like a breeze later on, they advised, factoring in rent inflation as well as the tendency for salaries to increase over time. Also, moving is expensive and a pain, so you're better off stretching financially on your first home and staying put.

Like my parents, my husband and I have loved being homeowners for the past 25+ years. I think it's been fine for us financially, we don't mind caring for a house, and we love our community. Our neighborhood has very few rental properties--almost no single-family homes where we live are rentals. But I suspect that the "homes are always a great investment" advice that my parents imparted was largely influenced by the runaway appreciation that many homes experienced in the 1970s (and relatively steady gains in the years thereafter).

Homeowners who purchased in the early 2000s and bore the full brunt of the real estate crash most certainly didn't have a positive experience, and many of them remain underwater.

In a research paper entitled "The Home as a Risky Asset," David Blanchett, head of retirement research for Morningstar Investment Management, noted that home prices have historically delivered real returns above inflation. But he also points out that homeowners have a tendency to underestimate their outlays for maintenance, which erode those returns. (Guilty!) Moreover, he notes that homebuyers court a huge amount of idiosyncratic risk; like the purchase of any asset, home-price gains are completely dependent on the price point at purchase.

For those reasons, I think it's unhealthy to consider a home an "investment" and instead think of it as the place you live, plain and simple. If you want to be a homeowner--for example, you want to live in a community where there aren't many rental properties that are up to snuff and you don't mind doing some maintenance work--then be a homeowner. (And try to avoid buying when the market is lofty.) But if you don't, then rent.

"Always prepay some of your mortgage principal each month."

My mom, the main bill payer in our household, imparted this advice when my husband and I bought our first house. The interest rate on our 30-year mortgage was a princely 8 3/4% and we were happy to get it. My mom pointed out that even if we were only able to pay $100 extra per month, we'd be able to pay off our house much faster than if we stuck with our lender's required payments.

If interest rates are much lower, the calculus about mortgage paydown versus investing elsewhere might not seem as clear-cut. But this advice still seems pretty evergreen. Yes, we might've been able to earn a higher return on our $100 a month by investing in stocks rather than prepaying our mortgage, but that's not the right comparison. Because the return on mortgage paydown is guaranteed to be whatever your interest rate is, less any tax breaks you're receiving on the debt, you're better off comparing mortgage paydown with investing in securities that are also guaranteed. That means cash, not stocks. Your lender is always going to charge you more to borrow than you're guaranteed to earn on your cash, so retiring the debt effectively earns you a higher safe return.

I'd also point out that my mother didn't say to steer everything we had to the mortgage paydown; we paid extra on the loan while also investing for retirement. People getting close to retirement with more of their portfolios in safe but lower-returning securities should favour a more aggressive mortgage paydown schedule. On the flip side, younger homeowners with long time horizons and equity-heavy portfolios should use a lighter touch with mortgage paydown.

"Most of your investments should go into stocks."

My dad gave me this advice when I was allocating my first 401(k). I remember remarking to him that I had looked at performance and found the money market fund had done nearly as well (for some presumably short period); wouldn't that be safer? His response was swift and decisive. "Stocks will do better." My dad stood by this advice for himself, too. His portfolio remained incredibly equity-heavy for most of his life.

My dad's bias toward stocks was, I think, influenced by his own experience. Not only had he seen stocks perform better than almost everything else during most of his investing career, but he had lived through the runaway inflation and bond-price rout that took place in the 1970s. He never really saw the merits of fixed-income assets.

The advice to favour stocks has, of course, stood the test of time, but I'd argue that time horizon is a crucial input. Even though my father maintained an equity-heavy posture in his portfolio well into his 80s, I also saw firsthand that volatility in the stock market gave him a lot of angst that he didn't need to have. He could have afforded a less volatile portfolio and still had more than enough to live on; he didn't need to take all that risk. My recommendation when I started helping him manage his assets was to reduce risk in his portfolio; that almost certainly hurt his results, but I think he rested easier in the long run.

A version of this article appeared earlier on this website

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