Biggest Myth In Personal Finance
As a financial planner, I’ll be sharing the biggest myth in personal finance, whether taxes matter or not, and give you 4 easy steps to avoid the consequences of this myth—which as far as I’m concerned, this simple framework doesn’t exist on the internet.
What if I told you all of your beliefs around money are wrong?
Imagine that you were walking through the store and bought everything that was on sale. A pair of kid socks, a book in a different language, and a can of beans. You don’t need these items, but you got them solely because they were on sale! In fact, you have no use of toddler socks, you don’t speak a second language, and you’re allergic to beans! Focusing on the SALE led to irrational choices. Similarly, your focus on this myth can lead to equally irrational decisions. This is why you’re bad at making money decisions, and why I’m going to show you how to make smart money choices.
While you don’t make the obvious mistake of buying things solely because they’re on sale, the way you make this bad decision is a little more subtle. Let me show you.
Have you ever had a question about money that you’ve taken to Google? (type in money, stocks, and credit cards) I think we all have at one point or another. And while we’ve been well intentioned in learning more about our finances, there’s 3 letters that can really skew your thinking and set you up to lose money and fail at your goals. Those three letters are T-A-X. Oftentimes, it’s the top suggestion from google, so it’s even easier to make this mistake. And this is where the whole problem exists.
All of my financial planning clients are in tech so I’ll use tech employees for example. Most tech employees are given company RSU (it’s kind of like company stock). Once they’re given RSUs, most people will go to Google to search, “what are RSUs?” and then once they get an idea of what RSU are, they’ll then go search “RSUs TAX.”
“...Once we learn about taxes, we start to dangerously frame all of our thinking toward minimizing taxes.”
Psychologically, once we learn about taxes, we start to dangerously frame all of our thinking toward minimizing taxes. And this is often the worst place to start. In fact, there are 3 things that are more important than taxes.
There’s a framework that I guide my clients through to make money choices around. The amazing thing is, this framework can often enable you to come to conclusions without having to understand the complex tax code or even investments. Let’s dive in.
Step 1 - Values & Goals
There’s a Harvard graduate named George Kinder that noticed a disconnect between people's money and their lives. He put together 3 questions to help align your money to what’s most important to you. I’m certain that 99% of people haven’t done this, yet it’s the most important place to start when making money decisions. Please take a minute to ask your spouse or partner these questions as you face various financial decisions and challenges.
Imagine you have enough money to satisfy all of your needs, both now and in the future. Would you change your life and, if so, how would you change it?
Essentially, this question is taking money out of the equation and seeing what you enjoy.
You are back in your current financial situation. Your doctor tells you that you have 5 to 10 years to live, and you will feel fine up until the end. Would you change your life and, if so, how would you change it?
This question forces you to think deeply about what is really most important.
The last question goes even deeper, but I’ll save this for clients when we have this deep discussion as I have even more questions to bring values and goals to the surface.
Not asking these important questions is like buying a book in a different language, when you don’t speak that language, nor do your values and goals have anything about learning a new language. We need to align your money to what’s most important to you. The SALE is a secondary consideration.
These questions help bring your answer to Step 1 to the surface. Now that we’ve addressed the most important place to start, you’re still susceptible to making an equally bad mistake as buying beans when you’re allergic to them. Step number 2. let’s go ahead and look at the second most important consideration.
Step 2 - Risk
Imagine you put all of your money into a single new crypto currency—we’ll call it Bad Bean Coin. You probably wouldn’t do it for several reasons. Mainly, you’d be worried sick about how it was performing. You’d be anxiously watching, pacing back and forth, checking for updates in the middle of the night in a cold sweat. This is known as risk tolerance. Risk Tolerance has to do with your willingness and has an emotional aspect to it. We need to know if you have an allergic emotional reaction to beans.
You also probably wouldn’t invest in Bad Bean coin because you financially can’t afford to lose all of your money. This is known as risk capacity, which is more focused on the numbers. Risk capacity is less about willingness, and more about your ABILITY to take on risk. Elon musk can financially afford to put $10 million dollars into bad bean coin. On the other hand, you financially cannot afford to put $10 million dollars into Bad Bean Coin. This is known as risk Capacity.
While you’re not silly enough to put all of your money in Bad Bean Coin, this is where I see people making a mistake that’s just as bad. I see this most often when people are holding onto a single stock, or RSUs from their company (mainly because of some faulty tax belief) and by so doing, they’re putting their financial and emotional well-being at stake.
They have a terrible allergic reaction both emotionally and financially to bad beans, but they buy it anyways because it’s on SALE! Over concentrating your net worth brings emotional and financial consequences that you can’t afford, but you do so anyway (oftentimes in the name of taxes that you don't’ understand in the first place). This is why a 50% tax bill doesn’t scare me as bad as overconcentration (or putting all your eggs in one basket). You tell me which one is worse: Paying 50% in taxes, or losing 50% of your net worth from a stock falling?
If you’re finding value in this information, please hit the like button.
Are you starting to see why tax isn’t the most important priority? I’m not kidding when I say that a focus on taxes can cause you to lose money and fail at your goals.
Here’s the next important thing that you should consider before taxes. While the first few steps focused on values and risk tolerance—which are mostly touchy feely, this next step is much more tangible. It’s where the rubber hits the road. And this is where most people actually start to think when making money decisions.
Step 3 - Financial Merit
While getting my undergraduate degree, I had a professor say that your biggest wealth building tool is your income. It’s your income, savings rate, and asset appreciation that’s going to make the biggest difference in building wealth. A lot of people believe that there is some tax-loophole that’s separating them from a big financial windfall and if they just understood the tax-code, they’d be much better off. Or as Dave Ramsey said, some people think “some double backflip Family Trust limited partnership thing “ to be the secret to wealth.
The biggest thing separating you from your financial goals and your dreams isn't taxes or even (most often) investment returns. The biggest impact to building wealth is a combination of your savings rate and your income.
But, our society has an obsession with complexity and glorifies tax savviness—despite it not actually being the driving force in actual wealth creation. People love to seem sophisticated, smart, and savvy—and one way people have conveyed that facade has been through talking about confusing things, such as exotic taxes. While that may garnish attention on social media or chat rooms, this allure is taking your focus of the third step which is assessing the financial merit of your decision. Is this stock in/out-the-money. Is this financial product overpriced, or undervalued? What’s the expected return? What are the financial repercussions to this action/investment?
There may be a few one-off cases where tax planning can make a huge difference in wealth creation, but for the vast majority of society, that’s not going to be the case.
It reminds me of a political cartoon I once saw which had two doors. One said, complex, but wrong and it had a huge line out the door. The other said, “Simple but right” and there were only a few people standing in line. The complexity sells, and sometimes justifiably so, but it just needs to be in order of priorities. Let me show you.
There are a few most common types of taxes: Income tax, capital gains tax, and estate tax. All of these taxes are based on you having something (either income or assets with appreciation). Thinking taxes is the deciding factor is quite literally putting the cart before the horse. You need to have income and assets for tax planning to play an important role.
Whether it’s honest curiosity, the allure for complexity, or following thes 3 steps…eventually you’ll need to examine the tax ramification of the decision. Let me help you view taxes in a much healthier light.
If you’d like to work together in taking a holistic approach to your money, more information below.
Step 4 - Taxes
The Truth is Taxes do matter, but not as much as you may think. Let me show you…
Income tax, capital gains tax, estate tax all have one thing in common…They’re all a percentage based upon an integer. If you earn $1,000, that money is taxed at 37% (for example). By definition, what would make more sense to optimize, the integer or the percentage of the integer? I hope this helps you realize the importance of optimizing the whole number first—before trying to optimize the percentage.
Have you ever heard anyone say “I can write that off” or “I can claim this as an expense.” or “It’s deductible.” You can better hope that they considered the first 3 steps before saying those words, because this thinking can be just as silly as buying everything in the store just because it’s on sale.
Free Tax Guide
Let me give you another example. Ya know how some credit cards give cash back? Well, taxes are kinda like cash back. You spend 1 dollar and get two cents back. Good deal right? Not exactly. It only really makes sense if you were going to spend that money in the first place. You wouldn’t spend that dollar for the sole purpose of earning two cents. Because you’d lose 98 cents in the deal. Similar to cash back, which is based on what you SPEND, taxes are based upon a percentage of a dollar amount that you EARN. So if you optimizing for a percentage, then you may be physically stepping over dollars to pick up pennies. That’s another reason why taking an action solely based on taxes is silly. The decision needs to align with your values and goals, risk tolerance and risk capacity, and have financial merit to it before we even consider the taxes. The fact is, taxes do matter, but only after you’ve gone through the previous 3 steps.
Saving taxes shouldn’t be your objective. It should be the cherry on top of your objective. I personally like to view tax-deductions or write-offs as a discount. I don’t go into the store for the sole purpose of getting a discount. I go into the store to buy something specific, and the discount is just a cherry on top that sweetens the deal a little. Roughly speaking, the discount is equal to your tax bracket. So the higher tax bracket you’re in, the more appealing tax discount you get.
Honestly, there needs to be a balance between these four steps and there may be one-off exceptions to this financial decision framework. So next time your in a store, know that a sale isn't bad…it may just be a lower priority.
