Are you too efficient with your money?
This article was originally written by Robert Schmansky, CFP® and published on NerdWallet's Advisor Voices.
Efficiency is good—when we’re efficient, we get things done. But efficiency can be harmful if not considered in the right context.
Advertising guru Rory Sutherland gave a wonderful TED Talk last year titled “Perspective Is Everything,” in which he gave examples of economic choices that seemed good but failed to take into account important economic elements in determining success. Case in point: The British post office, by investing in ways to increase delivery speed and improve customer perception of on-time delivery by a few percentage points, ended up nearly going bankrupt. As Sutherland pointed out, blindly seeking greater efficiency should not be the goal when we’re serving others; the goal should be happier consumers.
Likewise, investors often worry about how to maximize their efficient use of current money, rather than focusing on behaviors that will lead to increased happiness. Their attempts to become more efficient often lead to less happiness, which in my mind is the opposite of what we should achieve in our financial planning.
Let me share several areas in which I’ve seen people waste a lot of time worrying about efficiency.
Paying off the mortgage
Much has been written about whether a mortgage should be paid off or if it is better to carry the loan for as long as you can.
In the first camp, advisors and pundits say any debt is bad debt, and at today’s rates for savings it just isn’t worth paying 4% to 6% on a mortgage. In the opposing camp, those who support keeping a mortgage point out that the interest rate is lower than it appears, considering it helps homeowners to itemize and claim the interest as a tax deduction; and, perhaps more importantly, they note that housing prices tend to rise over time and homeowners can participate in that rise while putting their money to work in other areas, rather than putting too much into the house.
I find this decision, more so than most others, is one in which the personal aspects outweigh the financial. Would you feel more secure in 30 years if you had a mortgage and more money in retirement accounts, or a paid-off mortgage? Then consider if you can feel secure over the next 30 years with that same mortgage.
Most who come to me with this question know what’s right for them. Those in each camp have their points, but it’s important to realize that the outcome will be based on several things over which we have no control: the tax code, inflation, the local and national economies. Either decision may be best in the end.
Putting too much toward debt or retirement
This battle here is in keeping your cash from burning a hole in your pocket, while keeping it available in case of emergency.
I meet many people who see no material change in their bank account balance—which often is close to $0—even on payday. They send their money immediately toward debt or retirement accounts rather than saving a few months’ expenses in an emergency account. And while they may be saving a few dollars in interest, they live their lives stressed over their paycheck-to-paycheck lifestyle and concerned over where they will find cash in a crisis.
Retirement target date funds and balanced mutual funds
According to a new Investment Company Institute and Employee Benefit Research Institute study, use of these funds is at an all-time high within 401(k) plans, even though they are not the most appropriate investments. They are, however, very efficient. A target date fund is a type of mutual fund that automatically reallocates your investments as time goes by in an effort to reach a goal amount by the date you set for retirement.
As a personal financial planner, I see myself as a chef. These funds are fast-food meals. The individual parts are often available within the same 401(k) account as less expensive options than the target date fund itself, and can be used in appropriate quantities.
That being said, if you would otherwise not invest on your own, take the less efficient path. If you do not have an independent investment advisor who helps develop an overarching strategy, then at least a retirement target, target risk or balanced fund has your funds invested. Which leads me to…
Paying for sound financial advice
I’ve met too many people who are afraid to pay anything for financial advice. “I’ll have to overcome that amount with improved returns” is the belief. While we all can understand this mentality, it is entirely the wrong way to look at professional services that may provide multiple benefits.
I don’t want to pay for the services that I need, either. Every time I need to have something replaced on my car, I’m sure that if I took the time to research everything online, I could do it myself.
But I don’t have the time—to research online, do the actual work, monitor the results and try to be aware of the things I “know I don’t know” that may foreshadow future problems. While I’m sure I could squeeze out an extra several hours a week to work on this project, there are endeavors that would be a far more enjoyable and lucrative use of my time.
So, while I sympathize with those who spend hours every week in front of their computer to learn enough to manage their finances on their own, sometimes—many times—overcoming reluctance to pay that fee isn’t difficult, though it’s not always easy to see the value versus what might have been.
For many that value is simply the peace of mind of not having to develop and track spreadsheets and asset allocation percentages, or to trust yourself to make the right moves. Many people are so focused on watching the investments go up and down they don’t integrate short- or long-term tax planning into their investment strategy. Others overpay taxes or for insurance coverage because they have never had a holistic opinion from an independent advisor.
And while striving for perfection may seem laudable, the reality is that we will never be 100% efficient. We’re human, after all. Reality, according to Sutherland, “is a poor gauge of human happiness,” which is many times a more worthy goal than ultimate financial efficiency.