When it comes to finances, the conventional wisdom often is your enemy. What everyone knows to be true is typically what trips you up. The advice I give my clients often is unconventional—it sounds and feels unfamiliar and typically in sharp contrast to what they commonly hear—but I believe it is exactly the right thing to do in these turbulent times, and it has paid off for my clients over and over…
Conventional mortgage wisdom: Pay off your home mortgage as soon as possible using extra payments.
My unconventional wisdom: Keep a long-term mortgage, typically 30 years, regardless of your age or income, even if you can pay it off sooner.
Why it’s smarter: Owning your home outright saddles you with some pretty significant disadvantages nowadays, such as a lack of liquidity. Every dollar you give to the bank is one that you will never get back until you sell your home. You may need that money if you lose your job unexpectedly or have a large medical expense. Making extra payments is like stuffing money into a mattress—it doesn’t reduce the interest rate on the mortgage. All it does is reduce the amount of time that you will be making payments and the amount of interest you end up paying (assuming that you don’t sell the home or refinance before the mortgage runs out). And the less that you are paying in interest, the less you can claim for tax deductions.
Instead, put that money to work in a diversified investment portfolio, possibly one composed of a mix of passively managed “index” funds to keep expenses low.
Conventional IRA wisdom: Convert your traditional IRA to a Roth IRA. Although you have to pay income tax on the money you convert now, your withdrawals in retirement, including your gains, will be tax-free.
My unconventional wisdom: Forget about Roth IRAs, which are designed to get you to pay taxes earlier.
Why it’s smarter: Converting to a Roth IRA does nothing to increase your wealth. For example, I had a client in the 25% federal income tax bracket with a $100,000 IRA. If he converted the IRA to a Roth, he would have to pay tax and would be left with $75,000. Say the Roth doubled in 10 years thanks to shrewd investments. It would be worth $150,000. Instead, say the same client sticks with the traditional IRA and it doubles in 10 years to $200,000. After paying taxes, my client would wind up with $150,000, the same amount but without the hassle, assuming that he still is in the same tax bracket at the end of those 10 years.
Also, Congress may well decide to tax Roth IRA withdrawals in the future or make them subject to the Alternative Minimum Tax (AMT).
Conventional pension wisdom: If you retire with a pension, choose the “joint and survivor” option that companies often offer. It pays you income for as long as you live and keeps paying after you die for as long as your spouse lives.
My unconventional wisdom: Set up your own “joint and survivor” plan.
Why it’s smarter: Accepting the “joint and survivor” option means that you get as much as 25% less in each monthly pension payment. Instead, opt for the highest monthly pension payout or an up-front lump-sum payout, and purchase a life insurance policy, naming your spouse as beneficiary. If your spouse dies first, you can cancel the insurance and keep collecting the higher payout for the rest of your life.
Conventional long-term-care advice: Purchase long-term-care (LTC) insurance with lifetime benefits, which pays for at-home health care or nursing home or assisted-living care as long as you live. It’s very expensive, but you won’t have to rely on family members for care or spend down your assets, so your children will inherit more.
My unconventional wisdom: Opt for five years of LTC benefits rather than lifetime benefits.
Why it’s smarter: The average nursing home stay is less than three years, and fewer than 12% of people who enter a nursing home stay more than five years. I’ve found that a policy offering five years of benefits often (but not always) is sufficient, and premiums are as much as 50% less.
Consider adding on a shared-care rider. This lets you use the benefits offered by your spouse’s policy if you exhaust your own benefits.
Conventional inflation-fighting wisdom: Treasury Inflation-Protected Securities (TIPS), whose principal is adjusted based on inflation, are the ideal investment to help protect your portfolio from inflation.
My unconventional wisdom: You can’t rely on TIPS to protect your portfolio from inflation.
Why it’s smarter: If inflation soars, no one knows whether TIPS actually will work as an effective hedge. We have never experienced a prolonged inflationary period since TIPS were introduced a little more than a decade ago. If interest rates rise more quickly than the inflation rate rises, that would increase the yield offered by new Treasury bonds, possibly making them more attractive than TIPS and possibly driving down returns on TIPS mutual funds. Plus, there’s no guarantee that inflation will spike in 2011 or even 2012. High unemployment continues to stifle one of the main drivers of inflation—rising wages. If inflation remains low, you actually could lose money in TIPS this year.
Conventional college-savings advice: The best way for grandparents to contribute to a grandchild’s education is a 529 college savings plan. These state-operated plans are designed to help families set aside funds for future college costs by offering tax breaks.
My unconventional wisdom: Most grandparents should skip 529 plans.
Why it’s smarter: There’s no assurance that your grandkids will need the money. They might win scholarships or not go to college at all. What’s more, their parents might incur problems of their own, such as divorce or job loss, causing them to raid the account that you helped fund. Another drawback is that 529 plans limit options for investing money. Most important, you may need that money yourself for health-care or other expenses. Better: Talk to your estate-planning attorney about setting up a tax-free trust for your young grandchild, and stipulate that it remain untouched until the child reaches retirement age. Over the long run, that will serve the child much better than your contributions to a college fund.
