Wouldn't it be nice if financial planning was simple and the same financial strategies were applicable to most everyone? Unfortunately, there are no cookie-cutter approaches to financial management. From investment management and tax planning to estate planning and insurance, good financial advice should be customized to each person’s unique goals and objectives. Yet, countless financial “rules of thumb” continue to be cited, often encouraging the implementation of strategies that may not be the best fit, or worse, might even be inappropriate for someone’s situation. Depending on your circumstances, the following financial rules may be better off broken.
You should consider having a mortgage for the tax deduction – even if you are retired
Deducting mortgage interest on your tax return, where applicable, can be a great way to reduce the actual cost of carrying mortgage debt. It may be true that record low mortgage rates help make mortgage debt more palatable and some savers may actually be better off with a mortgage. However, a mortgage is still debt and you will incur interest expense (just less) - when you deduct it. Be sure to carefully review your numbers before carrying a mortgage later in life – especially in retirement. Too often accountants and taxpayers focus squarely on taxes, ignoring the “sleep at night” benefits of eliminating a mortgage. This is especially important during retirement when cash flow may be lower. Consider limiting the amount of debt you carry with you into retirement even if your deductions might be a bit lower.
Consider saving 10 percent of your income toward retirement
Few Americans are saving enough each year. According to the U.S. Bureau of economic analysis, recent personal savings data in the United States shows that the average American is saving around 5.6 percent of their income.
While a retirement savings rate of 10 percent would be an improvement for many, it is not necessarily sufficient for everyone - It is simply a starting point. It is critical to establish a game-plan plan to answer questions like - how much is currently earmarked for retirement? When do you plan to retire and what are your anticipated retirement expenses? What role will social security and or pensions have in addressing retirement income needs? Are you financially supporting your parents or adult children? Do you have a plan to address health care costs or long term care expenses in retirement? While an increase in retirement savings is generally a good thing, there is no general rule of thumb to reach retirement so consider calculating your unique number – the amount you need to save and earn to achieve what retirement means to you.
Home equity line of credit as a sufficient cash reserve
Many financial experts disagree about the best way to protect yourself against the financial curve balls that life can throw at you. From 3-6 months of expenses to a home equity line of credit (HELOC), there are many different approaches to establishing an emergency fund. Using debt of any kind, including a HELOC, is one of the more aggressive approaches to addressing an emergency fund. Sure, keeping less cash on the sidelines and more money invested can provide some savers with the potential for higher earnings. However, what goes up may also come down and cash reserves have no business being invested like a retirement account.
Additionally, it is not always a guarantee that the credit you are counting on will be there when you need it. For example, the panic during the financial crisis caused many banks to revoke HELOCs and reduce credit limits at the time when they were needed most. Simply put – you cannot rely on credit as your first line of defense against emergencies. For many, there is no substitute for a good old fashioned cash reserve.
Consider the adjustable rate mortgage – you can always refinance later
Adjustable rate loans (ARMs) often boast lower interest rates, tempting some homeowners to jump into these loans. According to Bankrate.com, the average rate for a 30-year fixed-rate mortgage is approximately 4.15 percent. In contrast, the 5/1 adjustable-rate mortgage is only 3.24 percent. (With a 5/1 ARM, the rate is fixed for five years and adjusted annually thereafter.) Sure, an ARM could be appropriate if you are absolutely certain that you will be selling the house and moving out in 5 years. However, many homeowners incorrectly assume that they can simply refinance the loan if rates are higher. While you can certainly refinance after the term, you may be doing so at significantly higher rates, leading to unnecessary interest costs. Consider avoiding loans that back you into a corner - flexibility can end up saving you money in the long run.
The percentage of your portfolio invested in bonds should equal your age
Is it a good idea to rebalance your portfolio as you get closer toward retirement? Yes. Should you overexpose your portfolio to bonds while limiting your allocations to other asset classes as you get older? It depends. Like other financial strategies, devising the most appropriate portfolio requires proper planning that takes into account your complete financial picture. While investing too much in stocks at a time when the market is expensive can prove costly, over allocating to bonds at a time when interest rates may be on the rise can also be risky. Your physician isn’t going to send you in for an operation without a thorough analysis and your portfolio shouldn’t be any different. Consider developing a customized financial plan that can help align your portfolio with your life.
While financial rules of thumb can be helpful and introduce financial concepts, it is important to understand their limitations. Since each situation is unique, consider speaking to your tax, legal and financial adviser to determine the most appropriate strategy for you.
Kurt J. Rossi, MBA is a CERTIFIED FINANCIAL PLANNERtm Practitioner & Wealth Advisor. He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com, www.Independentwm.com and www.bringyourfinancestolife.com. LPL Financial Member FINRA/SIPC.