Don't be fooled by these 5 finance myths

The Momentum UK Team 31 March 2014

We all know that on the 1st April, we shouldn’t believe everything we read. When it comes to your finances, this applies 365 days a year - take a look at these 5 myths that could lead you astray when it comes to your money.

1. “You should always pay off debt before you start saving”

People often think that it’s always better to be debt free, so any extra cash should be used for clearing debts instead of saving. However, whether or not this is true depends entirely on your circumstances and the type of debt you have. At a basic level, it all comes down to interest. If you’re paying more in interest on your debt than you’re gaining on your savings, it could be - broadly speaking - better to pay off the debt first. For example if you have a credit card debt with an interest rate of 10%, and the best interest deal you can get on your savings is 2%, it makes more sense to pay down the debt first. If the interest on your debt is lower than the interest you’re getting on your savings, or it’s a very long term debt like a student loan, you can contribute some cash to your savings without losing money - although you will have to pay off your debt at some point! When deciding on your priorities you should also take into consideration the risk involved in the debt; for example, if you don’t make your mortgage repayments, you run the risk of losing your home. If you don’t have a rainy day fund, it is a good idea to put one in place - otherwise a sudden emergency like house repairs could mean getting into more debt.

2. “The golden rule when investing is buy low, sell high”

Buying low and selling high is probably what every investor really wants. However, you should never invest ONLY because share prices are low, or sell because they’re high - investing or disinvesting should be based on careful consideration of all factors involved, and the reality of investing is inevitably more complicated than a single “golden rule”.

Markets will fluctuate, and it’s important not to panic. Before you make the decision to disinvest your money, you should consider carefully the overall performance of the investment, and how investing or disinvesting fits in with your long term investment plan and attitude to risk. If you’re unsure about how to invest, take a look at our guide to investing for beginners and consider taking independent financial advice.

3. “There’s no point in taking out a pension - they don’t work”

There is sometimes a misconception that a pension is a product in itself - this is not the case. A pension is simply a tax-wrapper for an investment; you contribute cash into a pension, which is then invested with the aim of growing your fund to provide an income in retirement. When people say their pension has performed badly, what they mean is that the investments themselves have performed badly. Pensions can be a great way to enjoy tax free growth (within certain annual and lifetime limits) to make the most out of the money you put away, and also have the potential benefit of removing the temptation to dip into the fund before you hit retirement. However, you should of course always make sure that the way that your pension fund is invested is in line with your goals and attitude to risk.

Saving for retirement is important, and whatever the method you choose, starting early can mean that your fund could have more time to benefit from compound interest.

4. “Cash savings are risk-free”

When thinking about risk, it is easy to assume that cash savings are completely risk-free - this is not actually the case. When you put your cash in a savings account, your capital is typically guaranteed up to £85,000 per person, per institution if your bank is FSCS protected, in case the bank should fail. However, in spite of this safety net, savings are subject to inflation risk, which is the risk that the true value of your savings will deteriorate over time. For example, if you kept all your savings in an account paying 1% interest, and inflation (the rising cost of living) over a year was 2%, the value of your cash would have gone down by more than the amount it has earned. This is because the cost of goods and services would have increased at a greater rate than your savings have grown, meaning the spending power of your cash is reduced. For this reason it is crucial to find the best rate you can when choosing a savings account.

5. “Renting is cheaper than buying”

People tend to assume that renting is cheaper than buying. However, rents have soared in recent years and in some areas this is no longer true. A recent survey from Halifax found that, on average, the cost of owning a family sized home in the UK is now almost £1,500 a year cheaper than renting. The research assumed that a home buyer had a deposit of around 27%, and the cost of buying took into account household maintenance, repairs, minor alterations and insurance, as well as monthly mortgage payments. In London, where rents have become severely inflated, the survey found that homeowners pay £2,256 a year less than the average renter. Of course, before you can own a home you will need to save a deposit, which is what holds most people back from buying a home. Remember that the larger your deposit, the better the mortgage deals you are likely to be offered. A larger deposit may also mean that you are less likely to fall into negative equity.

So this April Fool’s Day as you try to spot the fact from the fiction, remember that it’s important to stay money savvy all year round!