Rules That Are Meant to Be Broken

May 10, 2013

It looks like the FAA may relax the rules on what types of electronic devices you can use while the plane is zooming down the runway about to take off.   I’m not sure it would have helped Alec Baldwin continue to play Words With Friends a little bit longer and avoid that confrontation, but it might make a lot of people (including me) happy. I’m a big fan of reading and my favorite thing to do on flights is to read. And lately I’ve been reading more on my iPad, using the Kindle app and my local library’s e-reader checkout program.(Bonus tip:  For those of you who love to read, check out this link to Overdrive, which is the program I use to check books out of my local public library for free rather than buying the book via digital download. It’s a great money saver!)  Sometimes, there are rules that need to be updated in order to keep up with the changing world.  Here are a couple of rules with your financial life that you might want to consider updating.

401(k) Contributions: From Max the Match to Max the Max

Most people I talk to say that they’ve always heeded the rule of “invest up to your company match” in the 401(k) plan. For a lot of companies, that would mean contribution level of 3%-6%. Guess what? In the world of “do it yourself” retirement preparation, where pensions are going away rapidly and Social Security is projected to not be fully funded in the future, it is becoming increasingly more important to put the burden of retirement funding on your own shoulders. 401k assets are usually the biggest liquid asset that soon-to-be-retiring workers have at their disposal. And, it’s going to be increasingly important for employees to have sufficient savings to self-fund retirement. At a 6% rate of contributions, there won’t be enough money for many people.

So maybe we need to tweak the “up to the company match” rule that many people operate under. If the new rule were “get to the IRS maximum ($17,500 this year plus an additional $5,500 if over age 50) level of funding,” that would help drive savings levels higher.  It is unrealistic to expect everyone to be able to get there overnight, but if contribution percentages start at the company match and are increased 1-2%/year (or more often if your budget can handle it), eventually that IRS limit will be reachable.

Mortgage Payments: From How Much to How Little

When buying a home, realtors will often talk about how much house you can afford. And, a mortgage lender will speak the same language. Their models are based on debt-to-income ratios and percentage of income calculations.

But is that what’s best for YOU or for THEM?  Let’s follow the money. How do realtors and mortgage brokers get paid? On a commission basis and that commission gets bigger as your purchase price goes up, so there’s incentive for them to encourage you to purchase the most house your ratios will allow.

I see too many people who used that method to buy a house and then something went wrong.  A job was eliminated, the house value went down significantly, or children came along and required more cash outflow than expected (isn’t that always the case, though?) and all of a sudden the house that fit into your budget according to your realtor and mortgage lender is now making you house-poor. Maybe it’s time to tweak that rule about affordable housing costs to “how little can I spend on housing?”

Imagine that your cost of housing (mortgage or rent if you’re not buying) could be covered by less than half of one paycheck.  That would allow you to withstand some adverse circumstances and not worry about how you’re going to keep a roof over your head. It would allow you to pay off any and all debt rapidly. It would allow you to save significantly toward your emergency fund and your 401(k) (see above).  If you spend less than 25% of your take home pay on housing costs, it would be very easy to reach your other financial goals.  Instead of using a rule that benefits those in the housing business, use a rule that benefits you.

These are just a couple of widely accepted financial rules that, if tweaked, can put you at a significant financial advantage for the rest of your life.  They may be a little different, a little unconventional, but like some of my friends have suggested over the years, “rules are meant to be broken.” And sometimes, that can be a good thing!