Today is April Fools' Day, and while I'm not planning any elaborate pranks (or am I?), I did think it would be a good day to share some of the most foolish financial products that you can be ensnared by.
The financial world has a lot of great products, things that help people in their everyday lives while not hampering them with outrageous fees or awful terms.
This post is not about those products. Buckle up, let's get started!
Financial Products That Can Make You Look Like A Fool!
There are so many products out there that aren't as promised, and that can end up ruining your finances.
Here are a few of my least favorite foolish financial products.
Celebrity endorsed prepaid credit or debit cards
A lot of people in the personal finance blogosphere were up in arms when Suzie Orman launched her own prepaid debit card that carried along with it some onerous fees – that were obviously bad for consumers. But her card is far from the worst, these cards vary from fees slightly better than reasonable to downright highway robbery.
Justin Bieber released a prepaid credit card that had fees for just about anything you could possibly imagine.
Bieber's SpendSmart card, for example, didn't seem all that smart when customers realized that the card came with a monthly fee of $3.95. To reload the card, customers would have to pay $2.95 if they re-upped with a credit card, or 75 cents from a checking account. If cardholders took money out of an ATM, they'd pay a $1.50 fee per withdrawal, plus whatever fees the ATM charged. Perhaps the most onerous fees were the 50 cents for balance inquiries at ATMs and a $3 charge for 30 days of inactivity.
While Bieber's card is hardly the only prepaid card with a legion of fees, it definitely up there. Do yourself a favor and skip these celebrity endorsed prepaid cards and find something better, like a checking account with a debit card and no fees!
A loan that needs a co-signer
One of the riskiest things you can do is to cosign a loan for a family member or friend. Why do most people cosign for a loan? They want to help someone to buy something they want or need, and they don't understand clearly what they are committing to. So what are they signing up for, and why is it a bad idea to co-sign?
When you're co-signing, you're signing up for a situation where the lending conditions are high risk. There's a reason why your family member or friend can't get a loan without your help. The bank doesn't deem them to be a good credit risk. Should you?
When you co-sign you're putting your own funds on the line, you are committing to pay back all of the money, interest, payments and fees if the other person does not (and chances are that they won't).
Co-signing can also complicate relationships. Whenever money is involved in a relationship things can get testy, especially if the other person stops paying on the loan.
Do what's best for your financial future and avoid co-signing on loans like the plague!
Actively managed stocks or mutual funds
If you're planning to get into investing, some people will suggest that you look into actively managed mutual funds in order to have better returns than the market in the short term, and even in the long term.
The problem is while some actively managed mutual funds can do well in any given year or over the long term, on the whole passively managed index funds tend to come out with better returns than most actively managed mutual funds.
One study from the Journal of Indexes took a look at a 16 year period and then compared net returns of wholly index fund portfolios versus portfolios made up of actively managed mutual funds. Index funds came out on top almost 83% of the time!
“index funds, when combined together in a portfolio, have a higher probability of outperforming actively managed funds than they do individually,” a phenomenon that was persistent in every scenario they tested. While the weighted outperformance of the individual funds was 79.9%, the outperformance of the index portfolio as a whole was 82.9%.
Do yourself a favor. Invest for the long term, and invest in a diversified portfolio of low cost index funds via a provider with low fees! Check out companies like Betterment, Wealthfront or WiseBanyan.
While I'm not in favor of outlawing payday loans like some might suggest (because I do think they have their place in very rare circumstances), I do think that they should typically only be used as a last resort. Why? The fees are outrageous. From Credit.com:
Payday loans are also much more expensive than other methods of borrowing money. In most cases the annual percentage rate (APR) on a payday loan averages about 400%, but the APR is often as high as 5,000%. A standard credit card has an APR of 12% and a standard loan APR is around 7%
There are usually much less expensive ways to borrow money if you have a dire need, and you won't likely have to pay an APR of 400% or more! Avoid!
Stated income, variable interest and interest only mortgages
Getting a mortgage to buy a house is one of the biggest financial decisions most people will make in their lifetimes, and as such it has the potential to be one of the biggest blunders you'll make if you choose the wrong kind of mortgage, or buy too much house.
So what are some types of mortgages to avoid?
Stated income mortgages were popular before the real estate bubble burst, and would essentially allow someone who has no verified or stated income to buy a house. While originally they were meant for self-employed borrowers, the requirements to get one of these loans kept lowering until the point where you didn't need any verified income or assets in order to get the loan. While these types of loans are much more rare these days, it's probably best to avoid buying a house unless you can in some way prove your income and assets will allow you to repay the loan.
An interest only mortgage is another risky loan type where you receive the loan and then only pay the interest on the loan for the first few years. The loans are risky for a number of reasons. First, while initially the payments are lower, the payments will rise after the initial “interest only” period. Many aren't able to make payments once the payment goes up. Second, you aren't going to be building much, if any, equity. That will make refinancing or selling your house tough in many situations. Finally, with an interest only loan you're paying a ton more in interest over the life of the loan.
Bank accounts with high fees
In this day and age when a myriad of free checking and savings accounts are available, there should never be a reason why you would sign up for an account that has a high number of fees for things like withdrawing money at an ATM, overdrafts or monthly account or inactivity fees.
Instead of staying with a bank because they've got a local branch around the corner or because you know someone who works there, do a bit of research and find an account that isn't going to make you pay through the nose. Check out our bank rates page here.
Financial advisors with a vested (and commissioned) interest
Going to a financial advisor can be good for your financial health, as long as you find the right one.
If you find one that works for you on a commission, based off of the products that they're recommending to you, you might want to think twice about their advice. While their recommendations might not always be the worst in the world, they're usually not the best either. They're not always looking out for your best interest, but looking for what can give them the largest commission.
Look to groups like The National Association of Personal Financial Advisors (NAPFA) to find a reputable fee only based advisor. NAPFA members take a fiduciary oath that says, “The advisor does not receive a fee or other compensation from another party based on the referral of a client or the client’s business“. That means you're much more able to trust what they tell you. As always, trust but verify the advice that you get!
Don't Be Taken For A Fool, Educate Yourself!
When it comes right down to it, no one cares about your money as much as you do. You owe it to yourself to educate yourself about the basics of personal finance, and figure out which products and services are in your best interest, and which are not.
I know I've used some questionable financial products in the past, but I figured out quickly which ones were harming my finances, learned from my mistakes, made amends where I could and moved on.
What foolish financial products have you used, or been witness to? Tell us in the comments!