Can You Be Trusted with Your Money?

An underlying assumption in much commentary about personal finance is that most people are terrible with money. Financially illiterate, manipulated by marketing, distracted by present concerns, and guided by emotions, the masses repeatedly make stupid financial decisions.

Ostensibly, the purpose of personal finance columns, books and seminars is to educate, to reveal the error of our ways, and illumine a path to financial enlightenment and prosperity. But sometimes there’s an insidious assumption behind the instruction: Even with education, most of us still lack the character – the self-discipline, the rationality, the focus, etc. – to make good financial decisions. Thus, “education” suggests that your best shot at financial stability and prosperity is to remove yourself from the equation. Instead, entrust your future to pre-set strategies that minimize your involvement. And for the big decisions, rely on experts, those chosen few who are smart enough and strong enough to be impervious to human foibles.

Depending on your perspective, this beneath-the-surface message could be either a cynical way to sell products and services, or represent genuine paternal concern (“We just want what’s best for you.”). But instead of debating intent, maybe it would be better to broaden the discussion. Maybe you should know yourself enough to decide if you want to be trusted with your money, and what advantages might arise from those decisions.

Consider the following illustration as sort of a self-evaluation of your interest in financial responsibility.

The Best Way to Pay Off Debt?

In Personal Finance 101, debt is understood as something to be carefully managed, minimized, and eventually eliminated. Because poorly-managed debt is a major stumbling block to financial security and often results from bad habits, the recommended “fixes” are usually pretty strict: cut up the credit cards, downsize, use all available funds to accelerate payoffs, etc. And don’t do it again.

So, when it comes to getting a mortgage – a big debt – the recommendation typically follows the same track: select the shortest term you can afford, and plan to make extra principal payments whenever possible. In practical application, this means opting for a 15-year mortgage instead of a 30-year one. To reinforce the wisdom of a shorter payment period (albeit with higher monthly outlays), you might see the following:

It’s simple, right? Assuming you can afford a 15-year monthly payment, it makes no sense to select the 30-year option. What’s the point of paying more interest over a longer period to borrow the same amount? And if there’s extra money available, additional principal payments each month will only pay it off faster.

This information is accurate, but it’s not the whole story. There is a compelling counter-argument that taking a longer term actually is the better option. Here’s why:

You can realize additional financial benefits by selecting the 30-year mortgage and saving the $645 monthly difference in a separate account. If this accumulation earns a return equal to the mortgage interest rate, it will pay off the mortgage in 15 years. To repeat: Paying the bank $1,912 each month or dividing the same amount into $1,267 for the bank, and $645 in a personal account earning 4.5% results in the same outcome.

Apart from the identical end result, consider how a separate accumulation delivers additional benefits.

Consider your cash flow

The monthly obligation is lower. There is a cash flow benefit in minimizing your monthly payments. And you’re living in the same home whether you pay $1,912 or $1,267/mo. But in the event of a financial emergency (loss of employment, medical incident, etc.), which amount would be easier to afford, and thus more likely allow you to stay in the home?

There is a growing accumulation under your control. This accumulation can be used for emergencies or opportunities. While larger payments also accelerate home equity, this accumulation is not under your control. The approval of a lender is necessary to access this value – and the refinance or line of credit comes with another payment schedule.

Potential tax deductions for mortgage interest are greater. The 15-year mortgage accrues $94,248 of interest. In the example where a 30-year mortgage is paid off with a lump sum in the 15^th year, the cumulative interest is $143,593, a 53% increase. If this interest is deductible, the 30-year schedule produces significant tax savings.

The gains from the separate account could be greater than the interest rate. (And even if they aren’t, it may not matter.) If the outside account earns more than 4.5%, the mortgage could be paid off earlier than 15 years, or result in a surplus after the mortgage balance has been paid. And even if the separate account underperforms the mortgage interest rate, the payoff change may not be significant. At 4%, a lump sum payoff occurs in the 183^rd month, just three months past 15 years. At 3.5%, the payoff comes in the 188^th month. For 15 years of the benefits listed above, will a few extra months really matter?

The math and the benefits of selecting a longer payment period while accumulating the difference in a separate account are airtight, and the end result – the mortgage paid in 15 years – is the same. So why would “experts” recommend the shorter term? Because of a belief that unless contractually compelled by an outside authority (in this case, the lender), most people don’t have the discipline to sustain this kind of a plan. And mentioning this option only tempts people to be irresponsible.

There are two problems with this perspective. First, if self-discipline is the issue, there are processes to deal with it. Just as when they participate in employer-sponsored retirement plans, individuals can voluntarily enter into agreements that psychologically “compel” them to save. Something as simple as authorizing automatic withdrawals from a bank account or a paycheck satisfactorily resolves the discipline problem for most households. And a financial professional who monitors the separate account provides an additional level of support and accountability.

The bigger problem is that many households accept the negative assessments of their financial character. Even after hearing the logic, seeing the numbers, and understanding how this strategy can be executed with automated systems, it’s not uncommon for the individual to say, “Well, I get it, but I don’t trust myself. Even with automatic deposit, I’d probably mess it up. Better to just send a big check to the bank each month, and know the mortgage will be paid off in 15 years.”

So…How do you evaluate your financial character? Do you trust yourself to save the difference?

For the Herd…or for Me?

No doubt, a lot of people spend too much, don’t save enough and make less-than-optimal financial decisions. If this group represents “the herd” in personal finance, and the goal is to provide education and strategies for this broad audience, maybe it makes sense to provide “safe” advice that protects people from themselves.

But there is another group, perhaps smaller, that attempts to save diligently, spend carefully, and educate themselves about better financial strategies. For them, approaches that require more personal responsibility, along with professional assistance, could certainly reap additional benefits. 

Lifetime Financial Growth, LLC is an Agency of The Guardian Life Insurance Company of America® (Guardian), New York, NY. Securities products and advisory services offered through Park Avenue Securities LLC (PAS), member FINRA, SIPC. PAS is an indirect, wholly-owned subsidiary of Guardian. Lifetime Financial Growth is not an affiliate or subsidiary of PAS or Guardian. 2017-36523 Exp. 3/2019