Everyone knows it’s good to save money, but some money-saving methods have consequences that will outweigh any savings.
But how can saving money costs you anything when you don't spend it? You'll be surprised at how much you can be losing—and not in terms of dollar value, but opportunity costs.
Here are some budget traps to avoid in any situation.
1. Extreme Risk Avoidance
Some people theorise that, as long as they never take any risks, they won’t lose any money. This is called the “winning by not losing fallacy”.
It’s true that investing your money outside the CPF carries some form of risk—whether it’s Exchange Traded Funds or Emerging Market Bonds, there’s always a chance of capital loss (being forced to sell assets for less than you paid).
Unfortunately, people with this mentality are trading a potential loss for a definite loss. Singapore’s inflation rate rises by around 3% per annum. The cost of living is constantly rising, and super safe methods (such as using fixed deposits) will never keep up. When you leave your money in a typical fixed deposit (0.8% interest), the inflation rate means you are getting returns of negative 2.8% per annum.
These negative returns compound just like savings, and can destroy your retirement plans if left unchecked. In order to cope with inflation, your retirement plan should have assets with returns of at least 5%.
This is obtainable through index funds, many insurance policies, and mutual funds. These are a little more risky than hiding the cash in a vault; but the alternative is to end up losing money because, well, because you were terrified of losing money.
2. Making a Compromised Buy
Sometimes, we want something and can’t get it off our minds. But at the same time, we don’t want to buy it because it seems too indulgent. In these situations, we may make the mistake of going for a cheaper alternative—of making a compromised buy.
See if you recognise this situation:
You really want an iFruit tablet. However, the cost is $1,200. Even though you have the money, you decide to save by purchasing an alternative brand, one that only costs $900. This apparently saves you $300.
However, over time you become unhappy with your cheaper counterpart. You are not satisfied because what you want, and wanted all along was the iFruit. So eventually you give in and purchase the iFruit anyway.
Unfortunately, your $1,200 purchase is effectively a $2,100 purchase. This is because you wasted $900 on the alternative tablet, which you needn’t have purchased at all.
When you are interested in buying something, try to make it a yes or no decision. Either buy the exact thing that you want, or save money by not buying anything at all. Don’t waste money on a compromise.
3. Rushing Home Loan Repayments
One of the most grossly oversimplified pieces of financial advice is to pay off your home loan early.
The theory is simple enough. The sooner you pay off the mortgage, the less interest you will be charged. But this is dangerously misguided: there is a good reason why even multi-millionaires have home loans, and choose not to pay them all at one go.
For starters, if you are using a private bank loan, you should know banks impose a prepayment penalty—often 3% of the remaining loan amount—for trying to pay off your home loan early. This is to make up for the interest that they would lose (so you are not really “escaping” interest rates).
Also, rushing your home loan repayments invites liquidity risk. For example:
Say you have saved up $200,000, and you owe $350,000 on your home loan. Your net worth in this context is negative $150,000 ($350,000 debt, minus the $200,000 that you have).
Now, say you pay all $200,000 into your home loan, at one go. Let us also assume you use a HDB loan, so there is no prepayment penalty. How would your situation change?
The mortgage is $350,000. Minus the $200,000 you pay into it, you still owe $150,000. Therefore your financial position, both before and after rushing your home loan, is still negative $150,000. You may be under the illusion that you’ve made progress, but financially you haven’t budged an inch.
There is only one difference: now that you’ve put $200,000 into your house, you have no cash on hand for emergencies.
If you get sick, injured, or have to go to court, you cannot extract that money from the walls of your house. You will be forced to resort to loans and credit, and your debt will be even worse.
As the cheapest, lowest interest loan you will ever have (3.6% per annum for HDB loans, and around 1.9% for private bank loans), your home loan should be paid off last.
Note: There are situations when it would be favourable to pay your home loan early. However, this issue is not as simple as many finance blogs or books suggest. Dealing with home loans is complex, and even seasoned property investors do not make prepayment decisions lightly. Always consult a financial professional before making such a decision.
For reasons of accuracy, we will say to never do this without consulting your insurance agent. For other reasons, we will tell you to never do this ever.
It is true that certain medical treatments (everything from Botox to a heart bypass really) can be much cheaper outside of Singapore. And they are usually cheaper in developing countries.
The first thing to realise is that in many developing countries, health authorities may be a lot less regulated. Should something go wrong while you’re abroad, you may be tacking on additional costs (and tacking on parts off the surgery room floor) when you need to be rushed back due to infections, misdiagnosis, improper care, etc.
The second factor is insurance. Many insurance policies may not cover you if you get treatment outside Singapore. True, it may be cheap enough that you can pay out of pocket—but if you need to be rushed back to Singapore because something goes wrong, you can forget about your claim.
5. Skimp on “Named Driver” Inclusions in Your Car Insurance
Add another named driver in the car insurance form? Forget it! It’s cheaper if it’s just your name, and your spouse, child or friend only drives it occasionally anyway. Or so you’ll think, until the very first accident where you’re not the one driving.
Should someone else drive and crash your car, you’ll be faced with incredibly high excess (the amount you are liable to pay even if the claim succeeds). This is assuming the insurance company is even going accept your claim—depending on the situation and insurer, they might just reject your claim and leave you to pay for everything.
Remember that accidents sometimes happen to the best drivers. If you want to save money and not add named drivers, make sure you are the only driving. Otherwise, pay the added premium—it’s a small cost compared to the consequences.
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