If you read a handful of books (or read a few money sites or listen to a few financial radio shows) by today’s popular financial gurus, and you will begin to notice the same advice being given over and over again. The advice is designed for the masses and meant to offer general guidelines that work for most people. Yet, have you ever stopped to think whether the directions being given is actually good advice? Here's my take on some of the most comment money suggestions given today:
- Save 10% of your income. This is a good beginning point IMO. The 10-10-80 budget, which is what I consider to be a good guideline for those just starting to manage their finances, lists 10% savings as the goal. That said, the budget also assumes that the "10s" (saving and giving) will get larger over time and the "80" (spending will get smaller.) So for those just starting out, saving 10% of your income is good advice. But for those five years down the road or so there needs to be some progress to get that 10% moving up.
- Borrowing for good debt is okay (defining "good debt" as debt that allows you to ultimately earn more than the cost of the debt -- generally thought of as student loans and a mortgage.) I'm willing to concede that this is at least fair advice if done within reason. By "within reason" I mean that college debt needs to be aligned with expected post-graduate earnings and a mortgage needs to be taken out on a house you can afford. Furthermore, I prefer that people take out “good” debt for as little time as possible. After all, debt, even good debt, is debt, which hurts cash flow and financial growth. This is why I paid off all my debt 15 years ago.
- Buy life insurance worth 10x your income. Not good advice. This is advice that many financial advisors give, but it is too simple to cover everyone’s unique situations. Instead, I like this formula:
Total need - total liquid net worth + a bit of cushion = amount of life insurance needed.
Using this formula, I have taken out 5x my annual salary in life insurance.
- You’ll need 80% of your income in retirement. Not good advice. It's too general and is based on what you earn, not what you spend. I suggest you estimate what you think you'll spend in retirement by creating a mock budget. Adjust it every two or three years. Then save to cover those expenses plus a little bit extra. Oh, and don't forget to factor in the impact of inflation.
- Get the full employer match to your 401k. Good advice. Why? It's FREE MONEY! And a lot of it to boot! If you average $50,000 per year over a 40-year career and get a 100% match on the first 3% you put into your plan, that's $60,000 in FREE MONEY before you add in any growth. In addition, it's a 100% return on your money. Investors are struggling to make 10% on a regular basis, so IMO, 100% is pretty good. ;-)
- Your total debt load shouldn’t exceed 36% of your income. Good advice in general. The only think I can add is that this 36% is the ceiling -- you should not be above it -- and the lower, the better IMO.
- Your home mortgage shouldn’t be more than 28% of your income. Decent advice as long as it's combined with my thoughts above. I would add that my preference is that you shouldn’t buy a house that costs more than 2 times your annual salary.
- When paying off debt, pay the debt with the highest interest rate first. Good advice mathematically, but bad advice psychologically. I won't go over the reasons I used to think the "highest rate" option was better but have changed my mind over the years, but if you're interested in more details you can read What's the Best Way to Pay Off Credit Card Debt?
There you have it. Eight common pieces of financial advice. What's your take on these? Do you agree with me on which rules offer good advice and which offer bad advice?