April 10, 2011

Personal Finance Truths I've Learned In Recent Years

A while ago I didn't know everything and I was mistaken about somethings.   OK so i still don't know everything and I'm undoubtedly also mistaken about some things.

You need an Emergency Fund

I probably first heard of the term Emergency Fund around 4 years ago.   Before that I wasn't even aware of the concept.   I know that having some money in the bank is good.   However I didn't really have the idea of keeping that money specifically for an emergency or having a fixed amount equal to several months worth of expenses.

401k loans are a bad idea

I remember many years ago one of my co-workers mentioned they were using a 401k loan to help finance the purchase of their home.   I had never heard of the 401k loan before then and it sounded like a good idea to me at the time.   Since then I've changed my mind on them.   A few years ago I found out that 401k loans can be called and made payable if you lose your job.   That fact makes the 401k loan a bad idea in most cases.   If you take such a loan you're taking the risk of a double whammy of being laid off and owing a large sum of money to repay the 401k loan.   401k loans also erode the growth of your retirement plan assuming you wanted your money to grow faster than 4-6% interest rate that you're paying yourself.

The top Tax Brackets Don't apply to All of Your Income

Long ago I held the common mistaken belief that if you are in the 25% tax bracket then you pay 25% of your income in taxes.    That is certainly not how our taxes work.   I don't know exactly when I used to think that but at some point I learned the truth of how progressive tax brackets really operate.  The top tax bracket only applies to additional dollars earned.   The tax paid on the first dollars earned is the same no matter how high the income is.

Social Security is Pay-As-You-Go

I used to think that our Social Security tax dollars were dutifully invested by the government and accumulating in some sort of giant government ran piggy bank.   Social Security is however a "pay as you go" system.   The existing benefits are paid directly by taxes from the current tax payers.   There is no giant piggy bank.   Well not exactly.  One really confusing part of it is that SS has a surplus trust fund.  So there is a piggy bank, but its just a surplus amount between the current taxes and current benefits.   That trust fund does not come anywhere near covering the total amount of taxes paid in and eventual benefit liability.

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