Whether you’re just starting out or nearing retirement, there are some rules to live by that can improve your long-term financial situation. While not all of these will apply to you, the longer you follow the investment and spending recommendations, the more impact they will have, so it’s important to begin early in life. With that said, starting late is better than not starting at all.
Max Out Your 401(k)
If your employer offers it, contribute at least as much as the amount they match, preferably more. The match portion is literally free money, so you can think of it as a higher salary. In other words, if you make $60,000 per year, and your employer matches 100% of your contribution up to 3% of your salary, you don’t make $60,000—you make $61,800. The employer match combined with compound interest on the entire balance is an extremely powerful tool.
The one exception is if you have a large, high-interest debt burden. The amount of interest you pay on that debt could far exceed any stock market returns that the money would otherwise make, even when taking the employer match into consideration.
Contribute to a Roth IRA
If your employer doesn’t offer a 401(k) plan (or even if they do), open a Roth IRA and contribute a portion of each paycheck. Because Roth IRA contributions are made after taxes, the returns aren’t taxed in retirement.
Don’t Buy Meme Stocks
No matter how great an individual stock opportunity seems, put a very low and hard limit on how much you invest in that sort of risk. Yes, you could become wealthy overnight, but the same goes for playing the lottery, and the odds aren’t much better. Stick with a mix of Vanguard equity and bond ETFs.
Don’t Shop to Scratch an Itch
This is especially important when it comes to big-ticket items such as cars, watches, jewelry, and handbags. While there is no doubt that buying an object of desire will bring you satisfaction, that satisfaction will also be short-lived, and another object will soon take the place of the original. This is how behavior patterns are established, and depending on the fraction of income you’re spending, those patterns can push out your retirement date by many years.
If you must spend money, spend it on something that at least has the potential to benefit you in the long run. For example, your health, experiences with family, or home improvement.
Don’t Refinance Property to Pay Debt
There are far better ways to pay off debt, and only two scenarios when it is acceptable to refinance a primary mortgage:
- To significantly lower your interest rate—without adding to the balance and with little or no money out of pocket.
- To leverage the purchase of another property. However, if the refi would increase your interest rate, you may be better off taking out a second mortgage or opening a HELOC.
As you pay a mortgage, every month the amount paid to the principal increases, while the amount paid to interest decreases. This amortization process results in your equity increasing faster as time passes. Besides any adverse effects from a change in interest rate, keep in mind that when you refinance into a new mortgage the amortization will reset. This means losing all the years of progress made as the amount paid to the principal slowly increased, so the age of your existing mortgage plays an important role in any refi decision.
Understand the Consequences of Debt Consolidation
On the surface, debt consolidation seems like a great idea—one payment is more convenient than several, you can potentially lower the total payment, and you may get an interest rate that is somewhere in the middle of the highest and lowest rates on your existing debt. What’s not to like? There certainly can be cases where debt consolidation would be a good choice, but it frequently isn’t, which is why you need to have a complete awareness of how each scenario will play out.
An important part of being financially aware is knowing the consequences of a decision in advance, and usually some simple math will make the right choice obvious. To illustrate this, I used the three example debts shown on our Debt Payoff Methods page and imagined taking out a loan to consolidate those debts. I entered the $22,000 total into the Debt Payoff Methods Calculator, along with an 11% interest rate (the three individual rates averaged and then rounded down), and assumed that all the $1,000 per month available to pay debt was used to make payments on the new loan. Your results will of course depend on your own financial data and the terms of the loan.
Test Results
- A debt payoff time of 25 months, which matches the time taken to pay off the last of the individual debts. When you have a single large payment, you’ll be paying on that debt for longer than you would have on most of the individual debts.
- More interest paid than in all but one of the three debt payoff methods.
- The psychological benefit of payoff is delayed until the very end. Paying off individual debts sooner can help you stay on track at a time when those zero-balance credit cards look awfully tempting.
- Depending on the minimum payment of the loan, there may be little or none of the emergency cash flow benefit that comes from paying off smaller debts sooner.
Don’t Use a HELOC for Anything Other Than Home Improvement or Leverage
Don’t use a HELOC for debt consolidation, vacations, weddings, or anything else that won’t either (potentially) add to the value of your home or provide equity in another. How much a major upgrade actually increases a home’s value depends on a lot of factors, and sometimes they simply don’t—but what they can do is increase the desirability of a property for potential buyers or tenants. Besides, a complete bathroom overhaul can easily turn that shabby cave into your favorite room, and there’s nothing wrong with enjoying the stay in your own castle.
Installing solar panels is an appropriate use of a HELOC. However, there are lenders who specialize in solar system loans, and their terms are frequently more favorable than that of a HELOC or second mortgage—which brings us to…
Optimize Your Home’s Energy Usage
Solar
Many residential areas endure a climate and electrical rates that make installing solar a no-brainer. In the more arid parts of the country, the total loan cost can be far cheaper than the equivalent energy from a utility company. However, it pays to shop around. The highest prices tend to come from the nationwide providers, so if you get a slick pitch from a uniformed door-to-door salesperson, you can bet their quote will be on the high side.
Local installers are almost invariably cheaper, in some cases by 30% or more. If you have a neighborhood social media group, ask for recommendations there, read reviews, and don’t move forward until you have at least three quotes and multiple lenders to compare.
Heating, Air Conditioning, and Windows
How old is your HVAC system? If it’s coming up on 15 years, it may be time for a replacement, even if it seems to be working fine. At that point it will be close to the end of its life, and newer models are much more efficient. Double-pane vinyl windows will also make a big difference, and addressing these two issues alone can cut your energy use by half or more, while providing the added benefit of making the home more appealing to new occupants.
