In a prior article, I discussed what I call the “cash tax,” referring to the fact that paying cash for your purchases comes at a very high price. As a simple example, one of my credit cards issuers is currently running a six-month promotion, affording me 10% cash back on all gas and grocery purchases. If I elect instead to pay cash, then I am paying 10% more than I need to. Why would I voluntarily pay an extra ten percent for anything? I never run a credit card balance, so interest is not a factor.
In an attempt to refute this irrefutable fact, some, such as Dave Ramsey, cite to a study which purportedly found that people who use credit cards on average spend 12 percent more than people who pay cash. The theory is that swiping a credit card does not come with the same “pain” as peeling off Benjamins, so credit card users spend more overall. So, according to Ramsey, I might get 10% cash back on a specific purchase, but that savings is offset by the fact that I am spending more. (But see the footnote below.)
As far as I know, Ramsey has never actually provided the citation to the report, but I will accept as true that, on average, credit card users spend more than those who pay with cash. Common sense supports the conclusion. There will be those who run out of cash before they run out of month, as the saying goes, but rationalize a purchase because they can put it on a credit card and worry about paying for it later. Had they limited themselves to cash, that purchase could not have occurred. Thus, the option of paying with a credit card caused them to spend more.
The “Choose Not To Participate” Principle.
But here is the factor that is always ignored when “studies” and statistics are used in this manner. If one is aware of the reality, and it is a circumstance over which they have control, then the statistic doesn’t really apply, because they can simply choose not to participate.
I don’t spend one penny more with credit cards then I would with cash. The scenario simply doesn’t apply. I really didn’t start using credit cards until after I graduated law school and got my first job as an attorney. In my prior profession, I functioned quite well without credit cards (I had one card out of necessity for renting cars and such). Instead, I carried around a wad of cash. I had more money in the bank, so there was no great pain associated with paying cash, because I knew there was more where that came from. My purchase decisions were based on the usual criteria; was it a good price, did I really need the item, and was it within my budget. Cash or credit card did not play into the decision.
Actually, in my situation, paying with a credit card is the more painful process, because my spending is tracked in excruciating detail. There’s no pain associated with buying a daily $5 latte when I can just pull a fiver out of the cash wad, but seeing the 22, separate $5 charges on my credit card bill at the end of the month really drives home that I am spending too much money at Starbucks. (A fictional example, since I rarely go to Starbucks.)
This “Choose Not to Participate Principle” destroys many of the financial tropes. Here are three such examples:
1. Credit card points are a joke because 25% are never redeemed.
In one of his many arguments against credit cards, Ramsey cites to another study which states that 25% of credit card points go unused. Again, I don’t doubt the study, but so what? Choose not to participate. Just make the decision to track your points and use them. Every credit card in my wallet allows me to use points for purchases. That is not the best use of points, since the value is much greater if used for travel, but if I had no use for the points, I would certainly cash them out. No doubt, the points that go unused are by people who just aren’t interested in that feature of their credit cards. You don’t have to be one of those people.
2. It’s better to pay off your house early than to invest, because you won’t invest.
When mortgage interest rates are low, as they are now, the numbers are irrefutable. You will do better financially by investing in a good index fund than by paying extra money toward your mortgage. If your mortgage interest rate is, say, 3%, then you are “earning” a 3% return when you pay down the principal. By comparison, the VOO ETF has earned over 40% in the past year, and over 17% for the past five years.
And the two concepts are not mutually exclusive. Let’s say you calculate the payments you would need to make to pay off your 30-year mortgage in 15 years. You could make the extra payments into a safe investment vehicle instead, and use that money to pay off your mortgage 15 years later, pocketing the greater return.
Yes, there are other intangibles to paying off your mortgage early, such as the peace of mind it brings as you approach retirement, but that is not the primary argument I hear to justify paying off the mortgage as oppose to investing. Rather, the argument is that taking the money and investing is all fine and good, but you won’t do that. Apparently your tiny mind can deal with the simple concept of paying more toward your mortgage, but the less specific goal of investing is just too amorphous. You’ll end up buying jet skis instead.
Again, you have the complete power to choose not to participate. Decide the precise extra amount you could have afforded to pay toward your mortgage, and instead set up automatic payments into your brokerage account. Whammo blammo, you’ve beaten the system. Of course, you will be subject to market fluctuations, but the average length of a bear market is 289 days, as compared to 991 days for the average bull market. A 15 year investment plan should weather any storm. And paying down your mortgage comes with risks as well, as amply illustrated by the real estate crash of 2008. You could end up dutifully paying off a mortgage on a home that is worth less than when you bought it.
Here is a great video by The Money Guy that explains some of the pitfalls to paying off your house early. This is a long video, but the case studies are the first topic of discussion:
But there are a number of other factors that go into the “invest or pay off mortgage early” decision. To show both sides of the argument, here is a video from Josh Scandlen on the topic. I think he uses overly conservative numbers to reach his conclusion, but it provides food for thought:
3. Don’t invest in individual stocks, because you can’t time the market.
Here is an exchange I see most every week on one investment group or another:
Question: “I’ve been looking into investing in Acme. Financials seem strong, and they have recently taken out patents on improved roadrunner hunting technologies. What are your thoughts?”
Answer: “You shouldn’t be investing in individual stocks. Successful investing is a long game. Just diversify across ETFs; buy and hold. You can’t time the market.”
What terrible advice. Why do people always need to make a religion out of their beliefs? There’s only one way to diet (or diets are bad), there’s only one valid political view, and there’s only one way to invest.
The advice given to diversify across ETFs is valid enough, as is the long view, but the mentality that you should never invest in individual stocks is insane, as is the claim that you can never time the market, at least as I define it.
If by “timing the market” you mean that one can never know with certainty when to buy and sell a stock – buying at the lowest point and selling at the highest – then that is true enough. But the market is replete with opportunities to anticipate trends of individual stocks, especially following severe crashes.
Using one of my own humble examples, Ford has been a veritable money tree through the last two market crashes. For the past 39 years, Ford has had the best-selling vehicle in America – the Ford F-series truck. The company is not going anywhere. Yet in the 2008 market crash, the stock dropped to a buck share! I loaded up on Ford stock at $1, confident that it would come roaring back, and sold two years later at $10. Find me an ETF with ten-fold return in two years. I didn’t time it perfectly, because it continued up to $12, but pigs get fat and hogs get slaughtered. My only regret was that I held back a little. As you may recall if you were in the market back then, it was unclear whether American automakers were going to survive. It was conceivable, although unlikely, that Ford could have gone BK, so I didn’t invest as much as I should have, with the benefit of 20/20 hindsight.
When the Covid-19 crash came in 2020, I was less timid. Ford stock dropped from $9 to $5, so not as much upside as 2008, but I thought I could at least double my money. The stock tripled in a little over a year. I happily took some gains and kept some shares for potential future gains.
Ford was not my only big win from the 2020 Covid crash. I simply pulled up a list of the biggest decliners, and from that list selected the strong companies that would almost assuredly come back as the pandemic waned. I invested in Delta Airlines (up 100%), Dynafax (up 300%), and GE (up almost 100%). The point is not that I am some great investor – wins are easy in that market – but if I had some blanket rule against investing in individual stocks as so many seem to have, I would have foregone some amazing gains. These gains far outstripped any of my index funds. If it makes you feel better, don’t think of it as timing the market. If the stock goes the way you predicted, then grab your gains and get out. If not, then make it a long term hold. Under either scenario, buying a solid company at an historically low price is a good strategy.
I know all the statistics about how investors who try to time the market don’t do as well as those who just buy and hold. Two things can be true at the same time. You can embrace that as your overall investing strategy, and still not turn a blind eye to timing possibilities.
Conclusion:
The next time someone quotes a statistical study to you, be it financial or anything else having to do with life, consider whether the statistic is immutable or avoidable. Often, as in the case of unused credit card points, you can beat the statistic simply by choosing to do so. Choose not to participate.
And be sure to read: The 0% Credit Card Strategy and Why Instant Gratification can be Financially Savvy.
A footnote:
Dave Ramsey argues that you should make all your purchases with cash in order to properly feel the pain of the purchase. He even goes into the purported psychology of using a credit card. You hand the cashier your card, but it is immediately handed back to you. Thus, to your subconscious, you did not give anything up.
But Ramsey admits that he uses a debit card for all his purchases. If his shtick is that you need to pay with cash in order to feel the pain, and so your subconscious will see that you are not getting anything back from the cashier, then why is he paying with a debit card? If the psychology is that you hand the cashier a plastic card, which is handed right back to you, how is a debit card any different than a credit card? I’m guessing Ramsey would then argue they are different because in the case of the debit card the money comes out of your bank account, but that throws out his entire psychological argument. If he is going to make our subconscious sophisticated enough that it understands the difference between a debit card and a credit card, then I think it only fair to assume that where your credit cards are automatically paid in full from your bank account each month, it will understand that there is no actual distinction between a debit card and credit card (other than giving up all the concomitant discounts).
Now that I think about it, that might be Ramsey’s point. He can still feel the pain using his debit card, because he knows he spending more than he needs to on every purchase.