For many years I have seen articles galore in the major magazines giving consumers “rules of thumb” about making financial decisions. In a society today where we want to get all of our information in sixty seconds or less, many of these magazines can talk one week about five dollar meals to make and then the next week discuss major financial decisions to make in your household. I’ve never really been a big fan of “rules of thumb”, so here are four major financial “rules of thumb” that I am simply thumbs down on when it comes to making smart money moves.
- Rule Of Thumb #1- 2% Difference In Interest Rate To Refinance – Many popular magazine and newspaper articles will suggest that you generally shouldn’t consider refinancing unless the difference between the new interest rate and your old interest rate is 2%. This “rule” makes very little sense to me. What you want to be considering are a handful of variables before you make a refinancing decision. How long do you plan to live in the home? What will be the overall up front cost of the refinance? How much monthly cash flow will you save from doing the refinance? How many more years will it set you back to pay off the entire mortgage? Where do you see interest rates headed? By going through these types of questions, you should be able to ascertain the breakeven point on how many months you will need to stay in the property to make the refinance work in your favor.
- Rule Of Thumb #2- You Need Six to Eight Times Your Income For Life Insurance Coverage – Most of the articles you will read in major publications will suggest that you buy a multiple of your income for life insurance. The truth is that there is no right or wrong when it comes to how much life insurance you need financially. What you should be doing is an analysis of two widely popular methods when it comes to figuring out your insurance need as a family. The first part of the insurance calculation is figuring out your human life value. This is really looking at what your life is worth in today’s dollars and much of this analysis was founded off of the pension fund decisions made after 9/11 attempting to fairly pay out families after that tragic event. The other analysis is much more mathematical, called a needs analysis. This looks at questions such as what debt would you want paid off at death, final and funeral expenses, setting aside money for your kid’s college education, and how much needs to be left behind so your family can maintain their standard of living. Between these two calculations, you can get a much more accurate range of how much insurance you need versus a rule of thumb.
- Rule Of Thumb #3- Save 10% Of Your Income For Retirement – This rule of thumb was created many years ago as a baseline of how much money you needed to save for a comfortable retirement. With the last ten to fifteen years overall sluggish returns in stocks and bonds, you should not count on this rule of thumb to meet your ‘work optional’ goals. The next generations will need to save a lot more than this amount of their income or build up a paycheck/continue to work strategy as they enter their golden years. It’s necessary to do a comprehensive retirement analysis to figure out exactly how much you need to save to take the guesswork out of the equation.
- Rule Of Thumb #4- You Will Need 70% to 80% Of Your Income In Retirement- Remember that when it comes to figuring out your retirement income there is what you will ‘need’ and what you will ‘want’ the day that work slows down. If you make $300,000, it’s not likely you’ll need 80% of that number in retirement. The key is going through your overall budget today and setting some benchmarks on what you ‘want’ in terms of income in today’s dollars. Once you figure out the ‘want’ number, all of the rules of thumb go right out the door.
A rule of thumb is exactly as it sounds — a very large sweeping generalization. While you can make a decision predicated on each “rule of thumb”, it’s best to make a smart money move and do the right financial calculations so that you can make the very best decision for your family. The only rule of thumb I’ll give you is to ignore these rules of thumb and focus on you and your family’s specific needs.
CFP®, AAMS®, AWMA®, CRPC®, CMFC®, CRPS®
Editor in Chief of Your Smart Money Moves
Co-CEO and Founder of oXYGen Financial, Inc – The Leaders in Gen X & Y Financial Advice and Services
Ted Jenkin is one of the foremost knowledgeable professionals in giving financial advice to the X and Y Generation.
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