We see a lot of money advice on the internet. However, even though it might be well-intentioned, it’s not always the best advice. In fact, some common money recommendations could actually cost you more in the long run.
In many cases, it’s mostly a matter of tweaking suggestions to fit your situation. Here are some financial rules of thumb to rethink.
1. Save 10% of your income for retirement
One of the most common pieces of advice is to save 10% of your income for retirement. However, depending on inflation, your projected lifestyle and other factors, that amount might not be enough. Some experts suggest that you might need to save more in order to retire comfortably.
On the flip side, though, are those folks with higher salaries. They might not need to save as much to reach their retirement goals, particularly if they expect to scale down spending later in life. If you have an employer match for your retirement account, you might be able to get away with setting aside a smaller share as well.
Rather than relying on a rule of thumb, carefully consider how much income you need to generate in retirement and work backward to determine how much you should set aside each month to reach your goal.
2. A house is an investment
Your real estate agent will probably tell you that a home is a great investment. However, you’re probably better off viewing your home as a lifestyle choice, rather than a moneymaker.
Even if you sell your home for more than you paid, you might not actually make money. Any gains you receive are offset by a variety of other costs, including mortgage interest, insurance, repairs and maintenance. There are also many hidden costs of homeownership that can reduce your overall return. While you might end up with a chunk of capital after you sell, don’t assume that it represents a net gain.
3. Keep your mortgage for the tax deduction
Rather than paying down debt, some homeowners keep their mortgage for the tax deduction. However, this might not be an effective way to save money in the long run.
First, a tax deduction reduces your taxable income, so it doesn’t provide dollar-for-dollar savings on your tax bill like a tax credit would. If you’re in the 22% tax bracket, for instance, you’ll save 22 cents for each dollar of the deduction. Depending on your tax bracket, this might not be as beneficial as paying off your mortgage. Your savings might be bigger if you pay less in interest than if you save a couple of hundred dollars on your taxes.
Finally, you might not even be benefiting from the mortgage interest tax deduction. For 2021, the standard deduction is $25,100 for couples filing jointly. However, you must itemize in order to claim the mortgage interest tax deduction. If your total itemizations — including mortgage interest — don’t add up to more than the standard deduction, you’re not benefiting financially from keeping your mortgage.
4. Pay off your mortgage before retiring
You don’t always have to pay off your mortgage before you retire. In fact, sometimes it makes sense to retire with a mortgage. If you know you’ll sell and downsize or if you would rather put your money into investments with higher returns, you might be better off keeping the mortgage — especially if it’s a relatively small expense and you can maximize your money in other areas.
5. You can expect your expenses to be lower in retirement
We often hear that expenses will be lower during retirement so you don’t need to save as much. However, a recent analysis from the Center for Retirement Research at Boston College finds that household spending for most retirees only drops by about 0.7% to 0.8% per year.
The idea that retirement results in lower expenses isn’t one that holds up to scrutiny. In fact, retirees often spend nearly as much as the average U.S. household. Don’t assume that you’ll have a much lower cost of living in retirement. Unless you make dramatic changes to your lifestyle, you’ll likely spend close to the same amount. You might even need to increase your retirement savings if you want to live comfortably later.
6. Spend 4% of your retirement savings annually to make it last
The 4% rule of thumb has long been a staple of retirement planning. However, a recent analysis from Morningstar suggests that you should withdraw 3.3% of your retirement savings each year if you want it to last throughout your golden years.
Part of the issue is that recent inflation suggests that you could end up eating into your capital if you withdraw 4%. On the other hand, 3.3% could prove too conservative if low inflation returns.
Another possibility is that you could withdraw more than 4% and not worry about dipping into your capital. But this approach means you may not leave behind any inheritance. The idea behind the 4% rule is that since you aren’t touching the principal, your money could last indefinitely. If you don’t mind spending down your balance, you could withdraw more than 4% annually and live comfortably, with your money lasting just long enough — even if you won’t leave much to your heirs.
7. Pay off all your debt before you start investing
We often hear that you should wait to invest until you’ve paid off all your debt — except your mortgage. However, in many cases, you could be missing out on compounding returns.
When building wealth, consistency and time are on your side. While it can make sense to first pay down high-interest debt, like credit cards, you might consider investing even while you still have student loans or a car loan. If you have low-interest debt, putting some money toward investing could add up to bigger gains in the long run.