Break These 5 Personal Finance Rules for a Wealthier and More Secure Retirement
Personal finance is full of rules. While some are helpful, others can work against you if they don’t fit your situation, especially in retirement.
Here are five personal finance rules you should probably break for a better and more secure retirement.
1. Buy low, sell high
Conventional wisdom dictates that when it comes to stocks, you should buy low and sell high. But would you believe that that method is actually high risk and typically leads to less than desirable returns? Stocks selling low are often in trouble due to deteriorating fundamentals or shrinking market share. When mutual fund managers recognize these issues, they sell, driving the price of the stock down. In other words, trying to buy low and sell high these days usually means you’re buying damaged goods.
A better rule of thumb is to buy high and sell higher. Many smart traders look for stocks that are near their yearly highs in strong industries. These stocks are typically trending upward, and the stock has proved its value before you buy it. The potential for more growth is consistently better than fishing for the bottom-feeder stocks.
2. Subtract your age from 100 to determine how much of your portfolio should be in stocks
Financial advisors recommend that when it comes to retirement savings, the younger you are, the more money you should put in stocks. This is because the older you are, the less time you have to recover from any downturns in the market. So as you approach and enter retirement, you should convert more of your volatile growth-oriented investments to fixed-income securities such as bonds.
The traditional rule of thumb has been to subtract your age from 100. The difference represents the percentage of stocks you should keep in your portfolio. For example, at age 40, 60 percent of your portfolio should be in stocks and by age 70, only 30% of your portfolio would consist of stocks.
But today, Americans are living longer, so that rule may be out of date. Financial planners now recommend that the rule should be 110 or 120 minus your age. Because you may need to make your money last longer, you’ll need the extra growth that stocks can provide.
Keep in mind that your investment plan should consider other factors such as inflation, your risk tolerance and financial goals.
3. Pay off all debt before retirement
Paying off debt before you retire makes sense. After all, the lower your debt payments in retirement, the more money you’ll have to pay other living expenses, from medical costs to travel. But does that include paying off your mortgage? Perhaps not.
Many people dream of a mortgage-free retirement, but with today’s historically low interest rates, you may be better off putting any potential “extra” mortgage payments into your retirement account. This gives your money more of a chance to grow, and if you invest well, your returns will definitely outpace interest paid on your mortgage.
Keeping a mortgage and putting those extra payments towards retirement savings makes even more sense if you are in a high tax bracket and have a large mortgage because of the tax breaks. Consider a taxpayer in the 25% tax bracket who pays $20,000 in mortgage interest. Those mortgage payments would amount to a $5,000 tax break on federal income taxes. The savings are even larger when you consider state income taxes.
DO prioritize paying off other debts, such as personal loans, credit cards, and car loans. Those types of debt tend to have higher interest rates and don’t carry any tax benefits. Here are 13 tips for managing your debt.
4. Replace 80% of your income for retirement
How much income will you need in retirement? Many personal finance experts suggest that you should aim to replace 80% of your pre-retirement paycheck. That means if your pre-retirement salary is $100,000 a year, you’ll need to make $80,000 annually from Social Security, pensions, portfolio withdrawals, and other sources of income.
Such advice is well intentioned, but perhaps not one-size-fits-all. Many people actually need less income to maintain their standard of living in retirement because they’re no longer contributing to retirement plans and paying Social Security and Medicare taxes. Others spend more when they first retire, then spending tapers off. Your actual needs can vary considerably.
To get a better idea of the income you’ll need in retirement, don’t look at your current income, but at your expenses. Will your mortgage and other debts be paid off? Do you plan on spending a lot on retirement? Do you have children that could be financially dependent on you in retirement? Do you plan on cooking at home less and dining out more? How about medical costs?
Of course, we can’t predict the future. But rather than looking at 80% as a hard and fast rule, it may be a better idea to come up with a customized figure based on planned and potential expenses. Once you have a good estimate of your retirement spending needs, you can compare that to a sustainable level of portfolio withdrawals and other retirement income to see if your savings are on track.
5. The four percent rule
Those who favor simplicity over a customized retirement plan often refer to the four percent rule. This rule dictates that if you withdraw four percent per year from a diversified portfolio of stocks and bonds, adjusted annually for inflation, then you’ll have enough to last for 30 years in retirement based on historical returns. For example, if you want $100,000 per year in retirement (not counting Social Security or pensions), you’ll simply divide $100,000 by four percent to get a target retirement savings of $2,500,000.
The problem with this rule is that the four percent rule was a product of the 1990s when interest rates were significantly higher. Other experts have suggested that a four percent withdrawal rate might be too ambitious given today’s low bond rates and lower projected return for stocks.
No withdrawal rate can ensure you won’t run out of money in retirement or, conversely, withdraw so little that you end up with more savings than you’ll need late in life. A better idea is to start with a reasonable withdrawal rate that has a decent chance of making your money last, then making adjustments along the way based on investment performance. Or, explore using a bucket strategy.
The One Rule You Should Follow
When it comes to your future, you can’t afford to make too many bad moves, but that doesn’t mean you always need to play by the same rules as everyone else.
What should you definitely do? Focus on retirement planning that takes your individual needs and circumstances into account and continue to adjust that plan as circumstances dictate.
The NewRetirement retirement planner makes it easy for you to really customize your plans and take control over all the details of your future finances.
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