If you’re looking for some relatively simple concepts to guide your finances, consider the following three rules of thumb in the coming year. They touch on budgeting, investing and retirement-plan withdrawals.
As general rules, they won’t apply to everyone’s situation. But at the least, they can provide a starting point for dealing with issues that have long vexed many people.
This framework can help determine how and where to spend your money. Under this rule, as explained by NerdWallet, you would allocate 50% of your after-tax income to pay for necessities including groceries, housing, utilities, transportation, insurance, any child-care expenses needed so you can work, plus minimum-required loan and credit-card payments.
Another 30% would go toward “wants” such as restaurant meals, gifts, recreational travel and entertainment. The remaining 20% would go toward further debt repayment, to build up an emergency-savings fund and then for other types of savings and investments.
“Over the long term, someone who follows these guidelines will have manageable debt, room to indulge occasionally and savings to pay irregular or unexpected expenses and retire comfortably,” according to NerdWallet, which recommends the system.
That’s the appeal. The challenge is in making this system work in reality, as devoting a mere 50% to necessities won’t be easy for a lot of people. Also, separating needs from wants can be difficult. As noted, NerdWallet divides credit-card and debt payments into two categories: Paying the minimum due would be a necessity, but applying extra money would fall into the 20% category for debt payments and saving.
If you can’t regularly meet the parameters, adjustments might be in order. For example, if you can’t adhere to a 50-30-20 mix, try for 60-30-10. Modifying a budget would be better than giving up entirely. And as much as possible, automate deposits and various payments so you don’t need to think about each decision.
One of the toughest challenges to investing is figuring out how and where to spread your money. Over time, a diversified stock-market portfolio will almost always outperform bonds, for example, but at the price of white-knuckle rides along the way.
Enter the 60-40 rule, which calls for placing 60% of your long-term investments into stocks, stock funds and other riskier investments. The rest would go into bonds, bond funds, perhaps bank certificates of deposit and other conservative holdings.
The strategy usually assumes you will rebalance at least annually back to that 60-40 mix, as the stock portion otherwise would likely creep higher over time. Alternatively, you could gradually trim your stock-market holdings as you age, putting more into the conservative category to lower your exposure to risk.
The 60-40 rule has fared reasonably well over time. From 1950 through 2023, a 60-40 mix would have generated a 9.3% average annual return, reports J.P. Morgan Asset Management. Stocks alone would have produced an 11.4% annual return over that stretch, and bonds alone would have delivered 5.3% annually.
Stocks, namely Standard & Poor’s 500 companies, have fared much better, but a 60-40 mix would have delivered a smoother ride without sacrificing too much upside potential.
One of the challenges to planning for retirement is estimating how much of your assets you can draw down each year, without raising the risk of depleting everything too early. A popular rule of thumb is that most people can pull out about 4% each year as a safe starting withdrawal rate. Recent research by Morningstar veers a bit more conservatively and suggests the withdrawal rate shouldn’t exceed 3.7%.
Why the change? Yields on bonds and savings vehicles have dropped a bit, and the surging stock market has pushed up valuations, suggesting lower returns down the road, Morningstar said in a recent research report. The analysis is subject to change with future market conditions and hinges on personal circumstances.
One simple approach suggested by Morningstar is to build a ladder of TIPS, or Treasury Inflation-Protected Securities, with different yields and maturities. A strategy built around these government-backed bonds would allow for a roughly 4.4% annual withdrawal rate in current market conditions. The downside is that the portfolio would be completely depleted after 30 years.
Other strategies recommended by Morningstar include delaying Social Security to reap higher annual payments later in retirement and using a “guardrail” approach to avoid big withdrawals during years when investments, especially stocks, are down sharply.
With the latter strategy, you would adjust your withdrawals based on the performance of your holdings rather than lock in on a specific percentage. During a stock-market retreat, for example, you might take out only 3% or so in some years, though that might require you to pick up a part-time job or other income to make up the difference.
Reach the writer at russ.wiles@arizonarepublic.com.
