The most daunting thing about providing financial analysis? Perhaps it is the sheer number of variables. The nature of the work means trying to draw meaningful conclusions in an atmosphere of pervasive uncertainty.
This may be why some financial commentators ignore the uncertainty and make very simple, definitive statements. A clear, absolute statement can sound better than hedging. Unfortunately, when it comes to finances, such simplicity can miss the mark.
Where cookie-cutter advice falls short
Here are some examples of definitive statements that don't necessarily apply to all situations:
- "You should put off taking social security payments in order to get higher amounts later on." Yes, delaying social security means you should earn more annually, but figuring out when to start taking payments involves more than determining which could result in the biggest monthly check. There is a cross-over point -- taking social security as early as possible pays off best at first. Ultimately those larger payments would overcome that, but only if you live long enough. So, the social security question hinges on one of the biggest uncertainties in financial planning - trying to guess how long you will live. To decide this, you have to think about your health, your family history, and whether or not you have a spouse who would be in position to collect survivor benefits should you die earlier. In short, this is far from a one-size-fits-all decision.
- "Always max out your retirement plan contributions." This is good advice in most cases because of employer matching and tax benefits that result. However, that word "always" is a stretch. You need to make sure you have planned for your financial needs and kept some money in reserve for emergencies before determining how much to contribute to a retirement plan. The tax penalties for early withdrawals are onerous, so it is essential to make sure you can commit that money for the long-term before locking it up in a retirement plan. If you frequently need to take out a personal loan to handle emergencies, consider reducing the amount you are setting aside for retirement to save personal loan interest expenses.
- "Manage your tax withholding so you don't get a refund." Many financial planners view getting a tax refund as a sign of inefficiency, because it means you have been letting the government hold your money throughout the year rather than earning interest on it yourself. That makes sense, but whether you would benefit depends on if you would actually make the effort to put that money into savings throughout the year. If not, having withholding do the savings for you is better than nothing - and besides, at today's interest rates, the benefit of getting your hands on your money sooner is not what it used to be.
- "Longer mortgages are better because they entail more of a tax deduction." The deductibility of mortgage interest is certainly popular, but it still involves paying interest. If you have the option of avoiding that interest by paying off your mortgage earlier, the question becomes one of whether you could earn more of a return than your after-tax mortgage rate by investing the extra money yourself. During the high-flying stock market of the 1990s, it became popular to assume that the answer to that question was "yes." In the 21st century though, it hasn't been such a sure thing.
The above statements are not necessarily bad advice, but they are badly delivered. In an effort to sound definitive, financial commentators make statements that ignore the possibility of differences in how this advice is applied to particular situations.
Apply some informed discretion as a consumer of financial advice. One size certainly does not fit all, and the better you understand your individual characteristics, the better you may be able to discern which advice fits you best.