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By September 14th and 22nd, Some of the best-known financial tips have outlived their usefulness. Having some guideline for saving, investing, or dividing up assets into different categories is always good. However, most of these rules were written before the last decade, so they may not be relevant anymore.
These four outdated rules are not valid anymore. Instead, here are four new financial rules:
Housing 30% Rule
The old rule says that if you’re paying 30% of your pre-tax monthly income for housing, you shouldn’t be able to afford any other expenses (like groceries).
That yardstick has been rendered unrealistic by soaring rents in most U.S. The average nationwide asking rent for a one-bedroom apartment reached an all-time high of $1,964 last year, according to real estate research firm Reis Inc., so you would need to earn almost $5,400 a month to qualify.
Even before the coronavirus outbreak, many people had found it difficult to afford to house. A study by the Harvard University Joint Center for Housing Studies released in 2019 showed that almost half of renters spend more than 30 percent of their incomes on housing costs. For 24 percent of them, that figure exceeded 50 percent.
“When housing takes up so much of your income, you need to be careful not to spend too much,” says financial planner Nicole Sullivan of PRISM Planning Partners. “You may want to consider moving into a cheaper location, staying at home longer, seeking a raise, or looking for another job.”
50 / 30 / 20 Budgeting Rule
This rule suggests that about fifty percent of your income should be allocated for “must-have” monthly necessities like grocery shopping, commuting, and rent. About thirty percent should be set aside for “wants,” and twenty percent should be saved.
While this approach makes budgeting easier, necessary expenses such as healthcare, tuition, and rent take up most of the average household’s paychecks. For low-income neighborhoods, more than half of their monthly incomes can efficiently be allocated towards housing, while allocating just one-third to needs may be excessive for high-wealth neighborhoods.
The savings rate assumed here is one where someone starts saving when they’re 25 years old and saves 20 percent of every dollar earned until they retire at 65.
Financial planner, Nivi Persaud of Transition Planning & Guidance, recommends breaking down expenses into ten broad groups, including rent/mortgage, utilities, groceries, transportation, health insurance, child support, education, life insurance, car payments, etc.
“Those broad categories make it easy for people to see where they can cut costs to afford something else,” she said. “Some will cut their food, entertainment, and personal expenditures to offset a rise in their mortgage payments.”
60/40 Stock/Bond Allocation
It’s not working lately. Stock and bond prices are dropping amid the highest inflation in forty years and rising interest rates. Markets expect another significant rise in interest rates next month. A stock market index tracking the 60/40 portfolio’s performance has been losing ground for the past six months and is down about 12 percent this year.
According to a recent Bloomberg poll, most professional and individual investors believe the 60/40 stock/bond allocation is still the best way to invest for retirement. However, financial planner Ben Offit at Offit Advisors believes it’s time to move away from the traditional 60/40 stock/ bond allocation.
Dr. Offit recommends keeping at least two to five years’ expenses in fixed investments. Allocating the remainder of the portfolio to equities (stock) makes no difference in percentages; instead, it’s just a matter of having enough assets to cover your needs.
Withdrawing from an IRA at age 70 1/2 could mean taking out too much during a down market and having a significant loss when markets turn up again. A better strategy might be to withdraw less during a down market and increase withdrawal amounts during a strong market.
You can use a 529 plan for college expenses if you want to save tax dollars by contributing pre-tax dollars instead of waiting until after taxes are taken out later. However, if you don’t need the money right away, you might want to wait until next year when you file your taxes to contribute.
Retirement 4 Percent of Savings
A 1994 study found that retirees could safely draw down up to 4 percent of their savings each year without running out of money within 30 yeas.
For current retired people who expect their savings rates to be low and their incomes to rise slowly, the 4% withdrawal rate may not be appropriate. Some financial experts recommend a 2.5% withdrawal rate instead.
Another option for investors who want to withdraw from their retirement accounts during bear markets is called dynamic withdrawals.
Bottom Line: Rules of Thumb Can Be Great Starting Point but They’re Just That—Starting Points. However, if someone wants to consider the “4%” (or any) rules, then that’s OK, but they should also consider other aspects of that: What’s the composition of their portfolio; how do they plan to spend during retirement; etc.