10 financial rules of thumb
When it comes to answering perplexing questions about money,
you can't go wrong with research. You can diligently study
a situation. Ponder alternatives. Consider nuance.
Or you can save yourself a bunch of time and make a pretty
good guess.
Just as in other areas of life, in the world of personal
finance -- buying a car, saving for retirement, paying down
debt -- there are a few rules of thumb. We're not saying
they are always true. We're not saying they fit every single
situation. But the experts we consulted say they are useful
guidelines that can get you where you need to go.
Should I buy or lease a car?
If you're just considering dollars, you're better off buying,
said Cynthia Anderson, certified financial planner and chairwoman
of the Financial Planning Association of Charlotte. Two
exceptions: If you're someone who buys a new car and trades
it in every two or three years, leasing may save you money.
Second, if you own a small business and will use your car
almost entirely for work, leasing can offer tax deductions,
Anderson said.
How much life insurance should I buy?
The old rule of thumb was to buy 5 to 10 times your salary.
Forget that, said Greg McBride, senior financial analyst
at Bankrate.com, an online provider of financial rate and
personal finance information. The old guideline, McBride
said, doesn't take into account your dependents' financial
needs. Instead, ask yourself what your income would cover
if you were alive: Braces? Mortgage? Groceries? College?Because
this involves estimating future expenses, it's best to try
an online calculator such as the one at Bankrate.com. (Go
to bankrate.com/brm/insurance-advisers/life-insurance.asp.)
In the meantime, you can figure how much you would need
just to replace your present-day income. For instance, if
your money earns 5 percent in interest, you would need $1
million in insurance to generate $50,000 a year for your
dependents.
How big of a mortgage can I really afford?
Lenders still say that your total monthly housing expenses
-- mortgage, interest, taxes and insurance -- should be
one-third or less of your gross monthly income, said a Wachovia
Corp. spokeswoman.
Other experts suggest you ask yourself additional questions,
such as: Is my job likely to change soon, and if it does,
will I earn less? Do I expect to have a child soon and if
so, how will that change my cash flow? Will expected expenses
with this home -- energy, renovations, yard maintenance
-- tip my cost higher than I can comfortably manage?
Do I take the car rental insurance or no?
Save yourself hand wringing the next time you're at a car
rental counter. Check now with your credit card company
and your own car insurer to see if they protect you when
you're renting a car.For instance, said John Harvey, State
Farm agent at the company's Park Road office, if you carry
collision and comprehensive insurance on your own car, many
insurers extend that to rentals. One caveat: Protections
may not apply overseas. But your credit-card coverage often
does.
When does it make sense to buy another car instead of repairing
the old one?
Tom and Ray Magliozzi, hosts of National Public Radio's
"Car Talk" and authors of the syndicated Car Talk
column that runs in MoneyWise, say from a purely economic
point of view, it's always cheaper to repair your current
car than to replace it. The only exception: If the car is
badly rusted, it's probably not worth it to attempt a major
repair.
How much of my income should I be saving for retirement?
Prepare to be depressed. The old wisdom was to save 15
percent of your gross annual income. Now, make that 18 to
20 percent, said Eric Clark, certified financial planner
with Rinehart & Associates in Charlotte. The reason
is simple: We are living longer and spending more.
After I retire, how much of my retirement money can I withdraw
each year?
Generally, aim to withdraw 4 percent of your retirement
fund annually, assuming you earn between 5 to 7 percent
interest on it annually, said Ellen Rinaldi, principal investment
counseling and research with Vanguard Inc. However, 4 percent
may not buy you the lifestyle you want and you may need
to supplement that money with additional earnings. That's
also true if you're single, because you may have less savings
than a couple but face similar expenses (a mortgage payment,
for instance).
If I get windfall of cash, should I put it in savings or
pay off debt?
Dave Ramsey, Tennessee-based syndicated radio talk show
host and author of "The Total Money Makeover,"
is known to his listeners as the guy who preaches that "debt
is dumb." So it may come as a surprise that the anti-debt
guru says if you have no savings and carry debt, you should
not write a check to Visa, but put the money toward a $1,000
"baby emergency fund." ("Baby" refers
to the size of the fund, not that it's for the little ones
running around the house.)"The baby emergency fund
gives you a cushion to take care of small, unexpected expenses
while you are working on getting out of debt," Ramsey
wrote in an e-mail response to our question. "Then
use the rest to pay off debts. Pay the small debts off first
because marking them off the list gets you excited about
paying off debt. If there's still some cash left over after
you pay off all your debts, then use it to fully fund your
(regular) emergency fund."
How much of an emergency savings fund do I need?
Three to six months' worth of living expenses. That's usually
the amount of time it takes to find a job, and job loss
is usually the reason you need the fund, said Mary Quinn,
director of Charlotte Saves, a nonprofit group that helps
people save money. Along with the fund, Quinn suggests you
create a written list of the only reasons you'll tap it
and keep it where you can see it.
When does it make sense to make an extra house payment?
First, be sure your mortgage provider won't charge you
a fee to pay ahead. If there's no penalty, make the extra
payment only if you don't carry higher-interest debt or
can't earn more in interest on your cash by saving it, said
Mary Quinn, director of Charlotte Saves.
