Four Personal Finance Rules That Need a Revamp

INDONESIAKININEWS.COM -  Some of the best-known rules of thumb in personal finance have outlived their usefulness. While it’s helpful to hav...

INDONESIAKININEWS.COM - Some of the best-known rules of thumb in personal finance have outlived their usefulness.

While it’s helpful to have a starting point for a housing budget or savings target, or for splitting an investment portfolio between asset classes, many popular guidelines date back to a time when the growth in real estate prices and wages was more closely aligned, student debt hadn’t breached the trillion-dollar mark, and stocks and bonds didn’t fall at the same time.

Here are four outdated rules, and suggestions for more realistic ways to think about finances.

Housing: The 30% Rule

The old rule says that rent should eat up no more than 30% of a household’s pre-tax monthly income.

That yardstick has become unrealistic in much of the country as housing costs surge. The median national asking rent hit a record $2,032 in July, according to online brokerage Redfin, meaning you’d need to earn nearly $6,800 a month to meet the rule.

It was already proving impossible for many even before the pandemic-fueled rise in rents. Harvard’s Joint Center for Housing Studies found in 2019 that nearly half of renters spent more than 30% on rent and utilities. For 24% of them, rent consumed more than half their income.

“Housing can easily take up more than 30% of one’s income now, especially in expensive cities,” said financial planner Nicole Sullivan of Prism Planning Partners. “But spending substantially more than that can cause tremendous strain. After all, you have to eat, pay taxes, cover medical costs.”

In general, Sullivan advises waiting for a less expensive place to come on the market, living with family or a roommate for a while, pushing for a raise, or even hunting for a new job.

Budgeting: 50/30/20

This rule suggests that about half your income should go to “must-have” monthly expenses like groceries, transportation and housing. Thirty percent gets earmarked toward “wants” and 20% goes to savings.

While this approach makes creating a budget less intimidating, necessary expenses such as health insurance and student loan payments eat up more of the average person’s paycheck today. For low-income households, more than 50% can easily go toward housing, while allocating 30% to wants may be excessive for high-income households.

The rule also assumes someone can start saving at a young age. If someone saved 20% starting in their early 20s, they’d be in good shape come retirement. But start saving at age 45 and you’ll need to bump up that percentage.

Financial planner Niv Persaud of Transition Planning and Guidance prefers the term “spending plan” to “budget.” She has clients break down spending into 10 broad categories, including housing, transportation, food, personal care, entertainment and savings.

“Those broad categories make it easier for clients to see where they can reduce spending to afford something else,” she said. “Some will cut spending on food, entertainment and personal care to offset an increase in housing expenses due to a new home.”

Investing: 60/40 Portfolio

A 60%-40% split between stocks and bonds has long been considered a classic portfolio mix. The idea is that stocks provide growth and bonds provide some stability by zigging when stocks zag.

That hasn’t worked recently. Stocks and bonds are both falling amid the highest inflation in 40 years and interest rate hikes by the Federal Reserve, with markets expecting another jumbo hike of 75 basis points next week. A Bloomberg benchmark that tracks the 60/40 strategy’s performance posted its worst first half since 1988 and is down about 13% this year through Monday’s close.

A Bloomberg survey found many professional and individual investors are still counting on the 60/40 portfolio to beat inflation in the long run, but financial planner Ben Offit of Offit Advisors thinks it’s an outdated concept.

Offit says clients only need to hedge against down markets when they’re close to retiring and drawing on their portfolio. Keeping two to five years worth of expenses in fixed income guards against needing to sell stocks into a down market. The rest of the portfolio goes into equities, and “that has nothing to do with a percentage basis,” he said.

Source: isorperspectives