As odd as it sounds after you read the title of this post, there's a part of me that loves the increased interest in financial literacy and sharing financial tips that we've seen in recent years. Our society's financial literacy is low and our economic problems are high, yet only a handful of states require schools to add financial literacy to their curriculum. So conceptually, I love the idea of people on TikTok, Instagram and Twitter to share ways to make money and establish wealth with their followers.
... but the advice has to be accurate. Provably correct. And share the full context as to why it's right. And in a perfect world, it should be shared by someone who can prove they know what they're talking about. But since social media isn't big on making people show their credentials, let's stick with it being provably accurate. And unfortunately, this isn't the case for so much of what I see online.
So I'm doing something about it. I'm going to share some examples of financial tips, money-making ventures and more that I see being promoted and share why they're either inaccurate or lacking in context.
My goal isn't to embarass anyone or to start an argument, which is why the username of each person you see will be blurred out. The only goal is to share what's needed to make sure you're not out here in the world acting off of incorrect financial advice. And I will do my best to prove why what I'm saying is ... provably correct.
I can quit my job and make money as a Forex Trader
If you have Instagram, there is a 100% possibility you've been sent a Direct Message from someone with a bio similar to this:
Short for Foreign Exchange, Forex is a catchall term that describes markets where investors can exchange one country’s currency for another. As an example, if you’re going on vacation to Canada, you can expect to make purchases in that country using American currency. At some point you would need to convert your US dollars to Canadian dollars, and a foreign exchange is an online marketplace that helps facilitate this transaction.
The potential for profit comes when investors exchange their money for a country’s currency they think will increase in value. If they are right, they can use this increased value to generate a profit in their native currency.
Let’s look at an example of a forex investor in the United States who capitalizes on an opportunity with the Canadian dollar:
By taking advantage of the Canadian dollars increase in value, in one day are investor can convert their US dollars to Canadian dollars, then back to US dollars for a $25 profit.
If this example seems like it’s too easy to invest in forex, it’s not: there are multiple foreign exchanges that operate 24 hours a day, five days a week all over the world. They have little to no barriers to entry compared to the traditional stock market. Foreign exchanges are also more lenient when it comes to leveraged investments, meaning forex investors can use loans to make trades at a larger volume than they would with their own finances.
So why am I not a fan of forex for the casual investor? ALL the reasons I just mentioned! It is a decentralized form of investment with less regulation and more options for investing money you don’t have. That freedom can be great for a knowledgeable investor, but if you look online, you see more people making money teaching others to invest on foreign exchanges then you do those profiting off the actual investment form. Why? Because understanding what makes your own country’s currency value fluctuate is a complex enough task. To think that in a couple hours per day you could understand those same complexities for the British pound, the Japanese yen, the Brazilian real … that’s a tall task.
As is the case with many investments you see online, there are certainly those who are talented at forex and able to turn it into a full-time gig. The danger comes when you try and convince the general public that a very difficult and hard to attain skill set can quickly replace a day job or an investment with more guardrails. I would argue it’s much easier and safer for the typical person to understand and invest in an index fund then it is for them to know whether to exchange their money for the Chinese Renminbi at 2 in the morning.
In summary, forex can work. But it’s a complex and large world not built for the casual investor. Don’t let that self-proclaimed Forex millionaire in your DMs convince you otherwise.
Looms are a legal way to multiply your money
If you work in an industry that involves giving advice on investments or loans, it’s highly likely that industry will be heavily regulated. And when it’s regulated, you can’t simply hop online and tell people what to do with their money. You may have to put a disclaimer after each post or give your in NMLS number like most people in home lending must do at the bottom of their communications. At the very least, your posts and even direct messages would likely be monitored by some back-office compliance department (like the one monitoring this communication right now). These regulations make sure that licensed people are giving reasonable advice to the public about legal investments and financial tools. It’s a big responsibility to be telling people what to do with their money, and government regulators like the Securities and Exchange Commission, the Financial Industry Regulatory Authority and even the Federal Trade Commission want to make sure no unsuspecting citizen is taken advantage of.
So, when you see someone online telling you that if you put in money to their Blessing Loom that you’ll get EIGHT TIMES your money back, with no disclaimers and no regulations, you should be concerned. But that’s exactly what was happening when Looms hit the scene about a year ago.
A Blessing Loom involves a person at the center of a diagram who is the recipient of that period’s contributions. There are many versions, but let’s look at one that involves eight people making initial contributions of $100 for the benefit of one person at the center.
The eight contributors at the outer ring of the loom deposit their $100, which flows through the loom to the recipient at the center, who receives the entire $800.
Once their money has been received, they will move out of the purple center and the two participants in pink will now move into a position as recipients of their own loom.
But here’s the problem: while there was only one participant who needed eight contributors for the initial loom, there are now two new recipients who will each need eight new members a piece to generate their $800. That’s 16 members in total that must be added to the circle.
Once these two recipients move on, there will be four new members at the center of their own looms, each requiring eight new contributors for a grand total of 32 new members. By the time you’ve completed even five cycles, you would need 256 new members to contribute $100 to ensure the next round of recipients get their full payout!
But forget the unlikely scenario that you find 256 people willing to put in $100 at the same time, because that’s not even the biggest problem with Looms. The biggest problem is that they are ILLEGAL! Looms are pyramid schemes; there are no goods or services exchanged for the participants to make money. Instead, they make their money by convincing other people to put in THEIR money. If you don’t believe me, believe the Federal Trade Commission. The diagram you just saw is from their press release warning the public not to invest into these, what they call “chain letter scams”. Thinking it’s not a big deal, and that it’s not like the government is paying attention to you for a little Blessing Loom? You’d be wrong there too, as the FTC partnered with Arkansas authorities to sue the operators of a Loom that required members to contribute over $1,000 to participate. What’s worse, they specify that these scams target black communities for new participants
So, the next time someone says they have an offer for you to make a guaranteed 800% return on your investment, check for the disclaimer. And if they don’t have one, it probably is too good to be true.
Susus are an easy way to build money as a community
Susus came on the scene around the same time as looms, causing many people to confuse the two. Whereas the Loom is illegal, Susus, also called Giving Circles, are legal but unlikely to work (in my opinion).
Giving Circles are, at their core, informal loan networks that can be set up between friends, families, coworkers, etc.
Giving Circles involve a group of people committing to contributing a certain amount of money into a community pot each month. In the first month, one participant will receive the entire pot of money. The following period, the next person in the circle will receive the entire pot, and so on and so forth; the circle is designed to continue forever.
Let’s look at an example of Giving Circle where four friends agree to contribute $200 month.
The first month’s recipient puts in $200 and gets back the entire $800 pot. The next month, a new recipient will do the same, and the circle keeps rotating.
That's how things work if the Giving Circle is running smoothly
It's important to note that unlike the Loom, a Giving Circle doesn't offer an opportunity to INCREASE your money. If the circle in our example is completed, each person will have contributed $800 and will have been the recipient of $800. The "magic" of the Susu is that for everyone except the last person in the circle, there will be a month where they receive more funds than they've contributed (e.g., the first month's recipient who received $800 after having contributed $200). For these participants, the Giving Circle is like an informal loan or a payday advance. But the last member of the circle gets no advance; they simply get their $800 in the same month they'd contributed $800. For them, it's no different than contributing to a savings account and then withdrawing the funds.
Another potential problem with Giving Circles lies with the fact that these tools rely on a group of human beings to collectively accomplish one of the most difficult financial behaviors: saving the same amount of money each month with no exceptions.
Saving consistently is hard, and life is expensive. There are societal factors, policy decisions and tax loopholes that make it far easier for people who have money to save than people who are trying to get money. If anything, that's why tools like Susus are so attractive. They use the concept of Ujamaa, cooperative economics, to hopefully provide a cash infusion to a member of your community in need. But everyone must save the same amount for it to work as intended, and statistics show it is shockingly hard for the average American to do this every month. A Deloitte study analyzed personal savings rates based on income levels from 1985 to 2017. While the savings rates of Americans may seem strong at just under 10%, the study shows that households whose incomes are in the lower 40% have had a NEGATIVE savings rate. They spend more than they make and have done so for over 30 years. Even for those whose incomes fall in the 40%-60% range, their personal savings rate didn't climb above 0% until the 2000s. The only people saving on a large scale are those whose incomes fall in the top 40% of households, and they are unlikely to need or be attracted to the benefits offered by a Giving Circle.
Let's go back to our example and see what happens if in the 4th month, one participant can't afford to contribute their $200.
The fourth participant in the circle has now contributed $800 in total, but only receive $600 in return. And the person who was unable to contribute might have had very valid reasons; they could have needed new tires, or to pay for registration for their children's schooling or some other unexpected life event. Regardless of the reason, even one month where life happens to one of your members means that someone gets the short end of the stick.
I think the Giving Circle is well-meaning and can be beneficial to close-knit communities when functioning properly. The risk of a breakdown in the circle, however, is too great for them to be recommended.
I can start a business and get a free G-Wagon Benz
There are few things more dangerous than a person giving complex (and often inaccurate) financial advice completely lacking in context. And if you think there’s no one out there who would do such a thing … let me introduce you to LLC Twitter.
When the pandemic hit and PPP loans were introduced, there were a series of self-proclaimed financial professionals giving people advice on how to use your own LLCs to create your own business and immediately turn to lenders for grants and small business loans. They shared advice like this gem:
… yea … this was shared in good conscience. And he is far from the only offender. Non credentialed user after non credentialed user shared a dizzying mix of legal and tax advice with little to no context, to the point that the nickname LLC Twitter was born.
Aside from the fact that many of these steps would likely constitute tax fraud or other financial crimes, the biggest problem with LLC Twitter is that the recommendations have gotten more absurd over time. Here is their most recent tip for the general public:
If you think this is a case of one person on Twitter making a comment, you’d be mistaken. This became a thing. Even Mercedes dealerships started promoting it. There was an article in Forbes about it! Many people were convinced that they could somehow get one of the most expensive cars around for free.
As is the case with many of these recommendations, there is a sliver of truth here despite the shocking lack of context.
It is true that some, not most, businesses can purchase vehicles and write it off for their taxes. But I would say most people are not quite sure what a write off is in the first place.
A tax deduction , also known as a write-off, is a tool that can be used to reduce the amount of income on which you pay taxes. As an example, if you had a $100,000 taxable income in used a $5000 write off, it would reduce your taxable income to $95,000.
There is a huge difference between reducing your taxable income by $5,000 and getting a $5,000 check, but unfortunately many people think they're getting the former and not the latter. In reality, you might buy something worth $5,000 that is a write off, but the write off might only reduce your actual taxes owed by $1,000. Some write-offs also don't reduce your taxable income dollar for dollar, meaning you could spend $5,000 but only see a small percentage of that purchase used to reduce your taxable income.
Even if you WERE eligible to write-off a G Wagon, whose base model prices can still crack $150,000, you would still have to find an incredibly large amount of money to pay what’s left on the car after the tax deduction. If you get a $150,000 for a car and get a $25,000 tax deduction, I’m not sure you can call it a win to have “only paid” $125,000 instead. And that’s IF you’re even eligible.
The Mercedes “tip” comes from a special type of tax depreciation deduction called a Section 167 expense, which is a valuable tool for legitimate businesses who need to purchase tools and machinery. Every time you purchase a tangible product, like a computer or in this case, a work truck, that product has a limited useful life. Eventually it will need to be repaired or replaced. The IRS realizes business owners have to buy equipment and then watch it become less valuable and less useful over time until they must buy equipment again, so they offer them the ability to take a tax deduction/write-off that represents the amount the tool decreases in value each year. This concept is called depreciation.
In many cases, the IRS allows you to take a depreciation write-off over a certain period of years based on the type of product you purchased for your business. You might be able to take depreciation write-offs for a computer over the course of 5 years, whereas purchasing an office furniture could allow you to depreciate its value over 7 years. Let’s look at an example of a business that purchases a laptop and takes depreciation deductions over a 5 year period.
While depreciating over several years is helpful, some business owners want a larger upfront write-off when they place their tool or machinery into use, which is why Section 167 is so valuable. This type of deduction allows business owners to take an upfront, lump-sum deduction of the entire expense for the tool, subject to certain limitations. Meaning instead of spreading out the deduction, purchasing an eligible 167 deduction – like say, a work truck – would look like this:
Why the fascination with using a G Wagon? Because in some cases, heavier vehicles offer a larger tax deduction. People have somehow put two and two together and believe that because the car is heavy enough there’s technically a tax deduction where certain businesses can write off car purchases, we should all start an LLC so we can buy a G Wagon for “free”.
Let’s quickly tie a bow on why this is so ridiculous. Remember that a write-off does not mean you get money for the write-off; it simply means the amount of income on which you pay taxes is reduced. Even if you get tax benefits for buying an unbelievably expensive truck, you still must pay for the truck.
Next, and this should be obvious: the IRS only gives these benefits if you’re using the truck or machinery while doing business. You can’t buy things for your personal life and use them as a write-off for your business. If you buy an iPad to use for work as a business owner, the IRS might let you take a write-off for the purchase. If you buy an iPad so your daughter can watch CocoMelon on it, that’s a personal purchase not a business expense. If you’re a building contractor and purchase a truck to haul supplies, that’s a business expense. If you start a business just to buy a truck even though it has no connection to the business, that’s a personal expense, and misleading the IRS about its use so you can get a tax deduction is illegal.
Lastly, I would say a general rule of thumb is to never take legal or tax advice unless it’s coming from a licensed professional familiar with YOUR situation. It should take a little longer than the length of a TikTok for someone to convince you to start a business, much less to do so and buy a G Wagon.
If I invest my money in the stock market I'll get a 10% return
I love this one, because if you have a full understanding of the market, you can actually use this often misunderstood belief to your benefit.
I often hear people offering advice on the stock market say that if you invest in the market, you'll get a 10% average return. But then they'll give an investment scenario that lets me know even many of them don't understand the difference between a 10% average and a 10% return.
It's not that the 10% number is wrong; historically, the stock market at large HAS seen average returns of around 10%. The issue is twofold: first, how your mind process that information, and second, the limitations of most investment simulators.
If I tell you that a portion of the market averages 10% per year, you probably have a strong enough understanding of how averages work to know that it doesn't mean a 10% return EVERY year. If an investment gives a returns 30% one year and -10% the next, that's still a 10% average. However, when you hear someone quickly say that the stock market averages 10%, it's natural to process it just as quickly as an every year return.
This reaction is compounded by the fact that there are countless simulators that investors can use to estimate what their account balances might be if they invest a certain sum of money over a period of years at a given return. The problem with these simulators is that they don't have the ability to predict what the actual year to year returns will be over this period, so they instead take whatever percentage you enter and apply it to your account EVERY year. And that's simply not how the stock market works.
Let's take a look at the returns over a 10 year period, ending in 2010, for the S&P 500 - the 500 largest companies on the US stock exchange.
I chose these 10 years because it represents one of the worst decades for the S&P 500 in recent memory. The huge losses in the early years and the Great Recession of 2008 led to an average return of 3.63%, far less than you'd expect from the 500 biggest companies in the US market. But to me, it leads to the perfect explanation of how to use basic investing tools to your benefit, and what can happen if you misunderstand the power of averages.
The risk of not understanding the power of averages lies in how you choose to invest. If you are overconfident in the consistency of the market and don't put money in consistently, investing in periods like 2001-2010 can lead to far less money at the end than you'd expect. Let's look at an example of what you'd have at the end of this decade if you contributed $10,000 towards an investment that generated a 3.63% return EVERY year, as opposed to putting it in the S&P 500 which AVERAGED 3.63% over 10 years.
Investing $10,000 in a tool that generated 3.63% EVERY year led to a return almost 30% higher than investing in the S&P 500, which AVERAGED 3.63% over the same period. Unfortunately, many investment simulators would show you the higher number that comes from investing at the same rate each year, which can lead to a false sense of security in the prospects for your investments. Since many people don't understand this shortcoming, they take the average return, plug it into a calculator, and make posts like this:
I love everything about this parent's intentions. They have the right idea. But it's literally impossible to say make this statement because we don't know what the next 63 years of returns will look like for the stock market. The only way you could make this projection is if you used a set rate of return every year which is, again, not how the stock market works.
Even if you used past performance (which are not indicative of future returns), the numbers wouldn't add up. If you use a historical returns calculator to see what would happen if we invested $10,000 in the year 1958 and left it there for 32 years, you'd see that we'd have a little over $2 million at the end of the period. No one should sneeze at $2 million, which is why the parent in our scenario should be commended, but it's less than half of the $5.4 million they projected.
People who take this phenomenon for granted could miss out on the importantance of practicing one of the most productive habits in investing: doing it consistently.
The stock market rises and falls, but when you invest consistent amounts each month, it gives you a strong opportunity to buy into the market at the lowest average price. This concept is called dollar cost averaging, and when put to use, there will be periods where you'd actually PREFER for the market to go up AND down, rather than giving you the same positive return each year.
Don't believe me? Let's go back to an example. We covered one of the worst decades in the S&P 500's recent history - 2001-2010 - now let's cover one of the best - 2011-2020. From 2011-2020, the S&P 500 average 14.49%, a strong return. In fact, the market generated a positive return every year except one, in 2018. For this example, we're going to assume that our investor practices dollar cost averaging, starting with no money but investing $500/month into the S&P 500 for the entire decade. Let's compare what they would have by experiencing the rises and falls of the market that led to an AVERAGE of 14.49%, with what they would have if they'd received 14.49% EVERY YEAR:
In this scenario, our investor ends up with over $6,000 MORE money by investing as the market rises and falls for an average of 14.49%, than they would by getting the same 14.49% return EVERY year.
How is this possible? You've heard the first rule of investing is to buy low and sell high. That's what you see at work in our example. Every investment has a cost, and when the market goes down by 4.38% as it did in 2018, the price of these investments did as well. But by contributing the same amount of money no matter what, our investor was able to buy more shares in the down market than they could if their investment earned a 14.49% return, which would have increased the price they paid in that year! So in 2019 when the market experienced a huge rebound of 31.49%, our investor in the actual market owned more shares of their investment, which means their growth outpaced what they would have had there never been a market loss.
It sounds crazy, but it's how the market works! It's how dollar cost averaging works! And once you understand it, you'll never forget the difference between the stock market giving you a 10% return, and the stock market AVERAGING a 10% return. Use this new knowledge to your advantage!
If I get a credit card in my child's name they'll be able to buy a house by the time they're 18
Another example of an idea that holds a sliver of truth but is severely lacking in context. If you're a person that has struggled to build and maintain their credit score over the years, it's likely you wouldn't want your child or children to deal with that same struggle.
Well-meaning parents often want better for their children and look for ways to give them a leg up, especially financially. Having an 18-year-old start off their adult life with a strong credit score can certainly pay dividends for them down the road. But can you get a credit card in your child's name, and if so, will it actually build their credit? And if their credit is strong, can they really use it to buy a house at 18?
The answer is yes and no. The the social media comment you see is really a half-truth. Let's start with the distiniction between your child having access to a credit card and actually having their own card.
When you apply for a credit card, the credit card issuer uses your credit score and income to make a determination of whether or not you'll be approved. It's based off of your credit and yours alone. Once you're approved however, many cards will give you the option of adding what's called an 'authorized user'. If you add an authorized user, that person will now be the beneficary - good or bad - of however you handle that card. If you make the payments on time, it will relect positively on your authorized user's payment history, even if they didn't pay a dime towards the bill. If you keep your credit utilization low, it will reflect positively on their credit as well. Their credit becomes a reflection of how you handle your credit cards, so if you don't handle it well then their credit will be damaged as well. That's very different than them having their own credit card with its own limits; they actually have access to your credit card. If you've been struggling with your own credit, it's not that easy to build your child's credit when their piggybacking off of your habits.
Another caveat is that not all credit cards allow minors to be authorized users, and even those who do could require a minimum age of say 13 or 16 years old.
If you have strong credit habits and your card allows it however, adding your child as an authorized user does have potential for long-term benefits. But unfortunately, strong credit isn't the only thing it takes to get a home loan. There is another important element that has nothing to do with credit; your debt to income ratio
When you apply for a home, your credit score helps determine your mortgage's interest rate. A person with a 760 credit score might get a 3% interest rate, while a person with a score below the required level could be denied altogether. The element that determines how much you can borrow however, is your debt to income ratio.
Debt to income ratio is a measure of your monthly debt obligations compared to your monthly income. As an example, if you have $5,000 of monthly debt payments and $10,000 of income, your debt to income ratio is 50%.
Banks use debt to income ratio to make sure applicants aren't overextending themselves with their new home loan, which could increase the chances of defaulting on the loan. So if your debt to income ratio is too high, you could also be denied even if you have a perfect credit score.
This wrinkle is what makes it unlikely for an 18 year old to be able to qualify for a home loan, as most wouldn't have an income high enough to be approved, if they have an income at all.
What's more likely in this social media user's case is that they cosigned their child's application, meaning the child had strong enough credit but needed their parent's income in order to be approved.
Cosigners take on an equal responsibility to repay a loan; if you cosigned for your child and they make late payments or don't make them at all, it impacts your credit even though it's not your house. It's not something that should be done lightly, but if you've raised an upstanding child it can surely give them a chance to add an asset at an extraordinary age.
To summarize, this social media tip is a little more involved than this person has shared, but still an awesome thing they were able to do for their child. And now that you know the other steps, it might be something you can replicate for a young person in your life!
In Summary ...
This post may end up being a part 1 of many, as the financial advice we receive increases and the line between accurate, inaccurate and misleading can sometimes be blurred. But when that line is blurred, I'll do my best to be there, and hopefully I'll never end up on the wrong side of one of these posts!