Few subjects are as distorted by myths, half-truths and falsehoods as money. While most people know enough to get through their lives, Mark Twain described much shoddy thinking about money when he famously said:
“It ain’t so much what we know that gets us into trouble. It’s what we know that just ain’t so.”
There are many reasons for the widespread state of confusion about money, but a major problem is simple lack of education.
As critics have pointed out over the years, most public schools do not teach personal finance or even basic concepts pertaining to money. Most colleges offer such courses, but they are typically electives, not requirements for the entire student body. Consequently, America has reached a point where, as Forbes reveals in its January 2010 article “America’s Financial Illiteracy”, only 50% of respondents could correctly answer two of three basic questions about money. Even worse, only 18% could correctly answer all three. Others have argued that our financial illiteracy helps fuel speculative manias (like the tech and housing bubbles of the 2000’s.)
Below, we’ll attempt to set the record straight on five of the biggest misconceptions people have about money.
Being Rich Means Earning a High Income
The word “rich”, in common parlance, often refers to someone who earns a high yearly income. Doctors, lawyers and professional athletes, for example, are frequently thought of as being rich. And indeed, many of them are. However, it is important to know that a high income alone does not necessarily make someone rich. In reality, whether you are wealthy or not is a reflection of your net worth, not merely your income. About.com defines your net worth as “…the grand total of all your assets minus your liabilities.” Essentially, it’s a measure of your overall, accumulated wealth, which includes income, savings, investments, business and/or home equity.
Using net worth as the criteria, a plumber earning $50,000 per year while judiciously saving and investing most of it can, in short time, be richer in real terms than a lawyer earning $150,000 per year while spending most of it. This implies that there are actually two ways to get rich: offense (making more money), and defense (saving or keeping costs down.) If your goal is to get rich, or even if not, you would do well to begin thinking in terms of net worth rather than just yearly income.
Raises at Work Are Earned by Seniority
Some of the most dangerous misconceptions about money involve salaries and wages. Foremost among these is the belief that getting a raise at work is the result of doing the same job for longer and longer. Under this way of thinking, simply hanging on in your current job will eventually induce your employer to pay you more. But in his classic book on management, Dan Kennedy writes that “…getting a certain job done has only so much value, and that value does not increase by the number of years a person does it or that person’s need for income.” Those seeking higher incomes, Kennedy advises, ought instead to look for ways to add more value in the job they are doing. Only when a clear line can be drawn from your performance to higher sales or profits can an employer justify paying you more.
While some companies do base raises partially on seniority, it is generally unwise to rely on that. You cannot control whether your boss rewards seniority, but if you can prove that your actions demonstrably boost the company’s bottom line, you can confidently request a raise or seek one elsewhere. The key lesson to absorb here is that raises (generally speaking) come from results, not time spent working.
Money & Time Are Correlated
A similar but separate misconception about money is that it is correlated with time. Most people, when they think about making money, instinctively think of a job. At most jobs, you are paid for each hour that you work on the premises, under managerial supervision. Over the years, this has led many of us believe that you must trade time for money. In fact, this is just one of several ways to make money. Venture capitalist Paul Graham wrote a simple but thought-provoking essay about this called How to Make Wealth. His main point is that fundamentally, money is made by doing something people want. All a company (and a job) is, under that way of thinking, is a collection of people working together to do or create things people want. “Your contribution may be indirect”, Graham writes, but that is all your current employer does.
The lesson is that you can do something people want, independently of any job. You could start a business, for example, that uses automated technology to sell a product that you create. Rather than being paid hourly, you are paid by the sale, which can occur whether you are actively working at the moment or not. Another way to make money is by investing in the stock or bond market, which (you hope) produces a return on your money without any involvement by you – simply because you invested it.
Stock Markets & Banks Are “Too Risky”
Some people – especially since the recession hit – actually store their savings at home because they believe the stock market and even banks are too risky. Instead, they think, it’s smarter and safer to keep their money nearby, where it can be watched. Unfortunately, this thinking is wrong for a few reasons. First, nothing is categorically “too risky.” The question always needs to be: risky compared to what? In this case, the risk of keeping your savings under your mattress (so to speak) is that it will be eaten up by inflation, which is a “…rise in the general level of prices of goods and services in an economy” according to Wikipedia. Worst of all, inflation occurs at about 3%-4% every year, which means the money sitting under your mattress becomes 3%-4% more worthless annually. Putting your money in a savings account (which might pay 1% interest) is a way to protect your money partially from inflation. Investing in the stock market is a way to potentially earn more than the rate of inflation. If you can make 8% on your money in the stock market, for instance, your after-inflation return is 4%.
Granted, there is the risk of bank failure or stock market recessions, but losing purchasing power every year by not doing either is a certainty. Additionally, your bank accounts are federally insured up to $250,000 in case the bank did fail.
Renting is a Waste of Money
Would-be apartment renters are often chastised by their home-owning friends or family that renting is a waste of money. After all, the argument goes, with a mortgage, you are building equity in the home. With an apartment, you are paying rent that you wont ever see again. It’s pretty convincing, and in some cases it’s certainly true. But it is not true in all cases, and there are two main reasons. The first is property taxes, which can be staggering and which virtually all homeowners pay. (Renters generally do not pay property taxes.) The second is a concept called opportunity cost, which NetMBA defines as “…the value of the next best choice that one gives up when making a decision.” Basically, if the amount you save by renting earns you a higher return (such as by building a business or investing in the stock market) than the equity you could be building in a home, it’s not a waste of money to rent.
Indeed, if we are talking from a strictly economic point of view, it would then be a waste of money to own. If you are undecided as to whether you should rent or buy, the first step (economically speaking) is to determine the opportunity cost of doing one versus the other. Only once you have done this will it be clear whether renting is a waste of money or the correct economic decision.
Guest post from Chris Bennett, the marketing director for Creditloan.com. Established in 1998, Creditloan.com has been providing insight, advice and news on a range of financial topics, such as personal loans, debt consolidation and credit cards. In addition to the thousands of articles, you will also find reputable service providers and tools that will help you with all of your budgeting needs.