Twelve (+3) Updated Money Rules

Reprinted excerpts from Kiplinger.com ...


Some traditional rules of saving and investing are due for an overhaul. Here are 12 restated rules:

1. Renting may beat buying. 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.

2. Consider a Roth. 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 every dime you withdraw in retirement is taxed at your ordinary income-tax rate. With a Roth, you forgo the upfront tax break, but all withdrawals — including decades of earnings — can be withdrawn tax-free. If income-tax rates rise, a pot of tax-free retirement income could be a financial lifesaver.

3. Focus on dividends. Invest in stocks that pay dividends. 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.

4. Personalize your emergency fund. 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. Retirees should keep two to three years' worth of expenses in money-market funds, short-term CDs or other liquid investments.

5. Think McCottage, not McMansion. 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%). With a down payment of 20% and a 30-year fixed rate of 5%, a couple with a $100,000 income can afford a mortgage of up to $300,000.

6. Age 66 is the magic number. 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.

7. Cut your credit-card debt, but not your cards. 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.

8. Lock in your retirement income. Without a pension, you're on your own 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.

9. Think single-digit returns. Reality check: 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. Think of the past no-growth decade as a bridge from the unsustainable high returns of the 1980s and 1990s to an era of more-moderate performance.

10. Retire your mortgage when you do. 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.

11. Spread your assets around. 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. If you're 30, you can tilt your long-term money heavily toward stocks but keep your short-term savings in easy-to-access accounts. If you're 60 and have a secure pension and little debt, you can angle for some growth with your long-term investments, perhaps putting 65% in foreign and domestic stocks. Cast a broad net.

12. Save early for retirement. 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). The magic of compounding will do the rest.

And for good measure, here are three personal rules I would add:

13. Differentiate between what you want and what you need.

14. Become a do-it-yourself expert!

15. Don't invest in things you don't understand.