Monday, March 19, 2012

Messing Up Good Financial Advice

Wealthy Boomer quoted the BMO Retirement Institute concerning some sound retirement advice about debt. Reading through the very sensible advice, it occurred to me that there are many ways to mess it up as I’ll show with some questions and answers.

Canadians’ “priority should be to retire free of debt, including a home mortgage.”

Q: Does this mean that as long as I am debt-free I’ll be fine in retirement?

No. Becoming debt-free is an important start. Then you have to build some savings for retirement in the form of a pension or your own savings.

“A paid-up home is the foundation of financial independence”

Q: Does this mean that I should buy the biggest home the bank will let me buy?

No. If you are going to buy a home, you shouldn’t over-stretch your budget. Think about what home you need rather than the biggest you can afford.

Q: Does this mean that I have to own a home to have a decent retirement?

No. Choosing to rent can be a sensible choice, but you should be planning to build even more retirement savings to cover rent during retirement. Homeowners have the option to sell a home and use the proceeds to pay rent. Renters need other savings to pay rent during retirement.

“If you’re paying 5% interest on a mortgage of $400,000, just by moving from a 30-year amortization to a 25-year one can save $70,000 in interest over the life of the mortgage.”

Q: Will a shorter amortization period guarantee me a comfortable retirement?

No. Many people build up lines of credit at the same time as they pay off a mortgage. In effect, they are saving nothing at all. The main value of a shorter amortization period is forced savings. But this doesn’t work if it doesn’t cause you to spend less. The goal is reduced spending, not just paying off the mortgage early. In truth, when we properly account for inflation, the savings from the shorter amortization period are much less than $70,000 (but still substantial). Paying less interest is good, but the forced savings is more important.

In the end, you can’t just focus on one area of personal finance and ignore other areas. You have to consider your finances as a whole to see whether you are headed to a comfortable retirement or not. No matter how good the advice is in a blog post, it is always possible to mess it up if you’re determined to live beyond your means.

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