The Not-So-Black-And-White Rules of Personal Finance
A lot of us understand personal finance from conventional wisdom that has been passed along through the generations or a basic economic class we took in high school decades ago. But many of these “rules” are out of date and need revamping. What was once a black and white area for our parents or grandparents in regards to finances may now actually be quite gray in today’s economy.
Here are nine personal finance rules that may or may not need to be broken for you to experience true, sustaining wealth.
- No frivolous spending.
Our grandparents grew up in a time where spending money was viewed as a sin. But you can’t cut spending altogether, regardless if it’s “necessary” or “frivolous.”
“If you don’t ever splurge, you’re going to feel frustrated and defeated and think, ‘This is no fun.’ You don’t want to spend too much—or be scared of spending anything,” says Maggie Baker, a psychologist who specializes in financial issues.
Life is too short to put all “fun” spending on hold while you attempt to accumulate as much wealth as possible. Be wise in how you spend your hard earned cash, opting to pay for experiences over things, because that will give you longer lasting happiness.
- Always use cash over cards.
By abiding by this rule, you’re admitting that you can’t handle the purchasing power of plastic. If you have the cash, it’s actually the perfect time to use a card, as long as you are diligent in paying it off every month.
For purchases you would have made regardless, like gas and groceries, using a credit card is completely acceptable as long as you commit to paying it off at the end of the month before it accrues interest. Using a card helps build your credit report and you can earn valuable free rewards from credit companies as well.
- Carry a balance to build credit.
This rule is just wrong. It stems from the misinterpretation of how credit works. You do not need to carry a credit card balance to build a better credit rating; you simply need to use credit to do so.
Use your credit card wisely and pay it off completely every single month. This will show creditors that you are responsible and you’ll also avoid any extra interest.
- Max out your 401k.
A 401k is an excellent way to begin saving for retirement. By all means, if your employer offers a company match, you should minimally meet that match, otherwise it’s like throwing away free money.
Anything over that match is up to you. A wise financial planner will help you determine how to best invest your money, which may not be in the form of a traditional 401k. Other investments may yield a higher return.
- Take the largest mortgage the bank will give.
This is a misconception that got us into the recent catastrophic housing crises here in the US. Ultimately, banks do not have your best interest in mind. They’re a business trying to make money, so the more you spend, the more they make.
To figure out a comfortable mortgage, this is a fairly good rule of thumb:
- Put at least a 10% down payment on a home, preferably 20% so you can avoid the extra PMI (Private Mortgage Insurance) costs.
- Select a 15-year conventional home loan.
- Aim for payment amounts that do not exceed 25% of your monthly take home pay.
There is no magic number to determine your ideal mortgage. Everyone’s situation varies. This is simply a good starting point for ensuring your mortgage doesn’t drown your finances.
- Pay off your house before saving for retirement.
You should always try to pay off your home as quickly as possible, but this doesn’t mean you can’t also start investing for retirement at the same time. With compound interest, the earlier you begin saving, the more you’ll have, exponentially, upon retiring. Continue to make faithful mortgage payments, but also establish yourself for retirement as soon as you can afford to. Anything left over can be applied as extra toward your mortgage payment every month.
- Tax refunds are good.
Wrong! Tax refunds, for the most part, are bad! Some people view a refund as “found money” and squander it right away. However, a tax refund is nothing more than the government holding onto your money and earning interest on it for an entire year!
By selecting fewer tax exemptions on your employer tax forms, you’ll have more money now and will be less likely to splurge your refund come tax season.
- Never take a pay cut.
Career paths are rarely straight anymore and oftentimes require taking detours. While conventional wisdom tells you to only accept positions that increase your pay, we live in a time where there are other considerations to factor in.
Taking a lower paying position now may mean you get other incentives you’re looking for, like the opportunity to branch out into something new, a job title you’d rather have than your current one, new professional experiences, better benefits, or moving to an area with a lower cost of living.
- Buying is better than renting.
This is not always the case. A few generations ago, renting seemed like “throwing away money,” but that’s not always true anymore. People are settling down later in life and renting is a very feasible way to accommodate this while you build wealth by other means. Also, if you can’t take the previous recommended mortgage steps, renting is an affordable way to live until you can make a wise home purchase.
As you can see, not all financial rules are absolutes anymore. While many will still be black and white for some people, others may be gray. It’s up to you to do your research to find out which rules of finance you should break or keep.