12 New Rules for Your Money
In this era of high unemployment, flat home prices and do-it-yourself retirement savings, some traditional rules of saving and investing are due for an overhaul.
In this era of high unemployment, flat home prices and do-it-yourself retirement savings, some traditional rules of saving and investing are due for an overhaul. In this slide show, you’ll see how we tweak some tried-and-true maxims of managing your finances.
Buying wins hands down when home prices are rising. But when they're flat or falling, it makes sense only if you get a great deal, your monthly payment won't exceed rent on a comparable home by much, and you'll own the home long enough to recoup your costs for both buying and later selling your home.
Although the traditional rule of tax planning is never to pay a tax bill today that you can put off until tomorrow, Roth IRAs and Roth 401(k) plans stand that rule on its head. With a traditional IRA or work-based retirement plan, you get an upfront tax deduction, but withdrawals are taxed at your ordinary income-tax rate. With a Roth, you forgo the upfront tax break, but all withdrawals in retirement are tax-free. Anyone, regardless of income, can now convert a traditional IRA to a Roth IRA, but you'll owe taxes on the entire amount. (See Why You Need a Roth IRA.)
During periods of market volatility, when stock prices tend to bounce around in reaction to political and economic gyrations rather than accurately reflect corporate fundamentals, dividends can provide a predictable income stream. That's not going to make you rich, but it is a comfort when other traditional sources of income have slowed to a trickle (see 10 Great Funds That Deliver High Income With Dividends and Interest).
The standard advice is to keep enough in savings to cover three to six months' worth of expenses. But a lot depends on the stability of your job and the predictability of your income. The greater the risk your income could drop, the larger your emergency fund should be. If you think your job is in jeopardy, aim to save at least a year's worth of expenses. Retirees should keep two to three years' worth of expenses in money-market funds, short-term CDs or other liquid investments.
If you decide you're ready for homeownership, stick with the traditional (and temporarily forgotten) rule of thumb that you can afford a mortgage equal to up to three times your annual gross income. Most lenders will limit your total monthly housing payment -- including principal, interest, insurance and taxes -- to 28% of your gross income (and your total debt load to 36%).
Although you can begin collecting Social Security benefits as early as age 62, your benefits will be reduced by 25% or more. Better to hold out for full benefits at your normal retirement age -- 66 if you were born between 1943 and 1954; older if you were born later. If you're willing to wait until age 70, you can collect the maximum retirement benefit for you and your surviving spouse. (See Secrets to Maximizing Social Security.)
Minimizing credit-card debt is a great goal, but closing old accounts could hurt your credit score. About one-third of your FICO score (the credit score most lenders use) is based on your credit-utilization ratio, which is the total of your credit-card balances divided by the total of your credit-card limits. A good target is to use 20% -- or even less -- of your available credit.
Without a pension, you have to figure out how to make your savings last a lifetime. You can use a portion to buy an immediate annuity, which will guarantee monthly payments for the rest of your life. The older you are and the higher interest rates are, the bigger your annuity payout. But you might want to wait for rates to rise before locking up your money.
It's time to set a lower total-return target, not only for stocks but for your other investments, too. You should be happy to get 6% a year if you've dialed down risk in preparation for retirement and downright joyous if your overall investments earn 8% annually over the next ten years. (See The 8% Solution.)
A house is a long-term investment with attractive tax deductions for mortgage interest and property taxes. It's great during your highest-earning years, but a monthly mortgage payment represents a major portion of most household budgets. One of the best ways to reduce your costs in retirement is to pay off your mortgage by the time you retire. Whittle away at your loan during your final years on the job, making extra payments if necessary.
There's no good formula for the right percentage of stocks in your portfolio -- especially the old 100-minus-your-age rule. A fresh idea is to start with 50% and slide the percentage up or down based on your personal situation. There are many high-powered alternatives to stocks -- such as emerging-markets bond funds, currency funds, commodities and exchange-traded funds -- that weren't common when the traditional advice was to invest heavily in blue chips.
Paying off debt should be a top priority, but don't let your single-mindedness get in the way of your long-term goals. If your employer offers a matching 401(k) contribution, save at least enough to capture the match. Otherwise, you're walking away from free money. Ideally, you should aim to save 15% of your gross income for retirement (include your employer match in that calculation).
