Personal Finance

Top 3 common fallacies of personal finance

When it comes to the world of personal finance, there are some common fallacies that I hear day in and day out. Here’s my top three list for 2007.

“It’s no use getting more money because the government just takes most of it anyway.”

Often I get people passing comments that their raise or bonus was not worth it because most or all of it was lost to taxes. There’s no question that we are a pretty highly taxed country and any income we make gets taxed. Regardless of where you live in Canada, you’ll never lose more than half. Here in Alberta, the highest marginal tax rate even when you combine the federal and provincial tax rates is 39%. In other words, in the worst possible case, you still get to keep 61% of every dollar you make. Most people will get to keep 75% to 64% of their hard-earned dollars. Don’t ever get mislead into thinking that you could lose all of the income you make or even lose more than you make. From my perspective, there is one simple rule to follow. Never, ever turn down money.

“I should have never bought RRSPs because they tax me when I take it out anyway.”

Quite often, this statement comes from those that are already retired who want or need to withdraw some money from their RRSPs. When you take money, you have to pay tax at your marginal tax rate, which means that if you want to spend a dollar, you need to take out at least a $1.33 to net a dollar. What retirees often forget is they got a tax deduction a long time ago when the money went into the RRSP. In other words, the government lent them money when they made the contribution. Although they have to pay that money back when the money is withdrawn, in most cases, they got a bigger deduction when they put the money in than the amount of tax they are paying when they take it out. For example, if you put the money in while you were working an in a 36% marginal tax bracket and you take it out when you are in a 25% marginal tax bracket, you just made 11% in a return based on tax. This 11% is on top of any investment in your return through investing. Sure, you might dislike the thought about paying 25% when you take it out but don’t lose sight of the benefit you got when the money went in.

“You should be able to get 10% on your investment return.”

Let’s just get down to statistics. If you look at the Canadian stock market (TSX) from 1924 to 2006, you have 74 rolling 10-year periods. In other words, 1924 to 1933 is a 10-year period. 1925 to 1934 is another rolling 10-year period. The average 10-year period of all those periods was 10.1%. However, when you start dissecting this a little deeper, you will see that only 38 of those 74 periods did the stock market make you 10% or more. Half the time, stocks are making less than 10%.

The bottom line is it is not as easy as some people think to make 10%, especially in the stock market. The news gets even worse when guaranteed investments are making a little over 4%. If you have a diversified portfolio, that means some of your money will be guaranteed at 4%, which means in order to make over 10% on the entire portfolio, some of your money needs to make 16% or more. When it comes to investing, make sure you have some realistic expectations about what your portfolio can do for you.

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