16 favorite money rules of thumb

Here they are, plain and simple. Follow these guidelines and your finances -- and nerves -- will be in pretty good shape.
By Liz Pulliam Weston
Sometimes, you just want an answer.
"Can I afford a new car?" "How much should I be saving for retirement?" "What's the best way to pay off debt?" "What's the right credit card for me?"
If you're a patient, detail-oriented type, you may be willing to sit still for an exhaustive lecture on any of the above subjects. If you're like most of us -- overworked, sleep deprived and in a hurry -- you'd rather skip the whole dreary "on the one hand this, on the other that" analysis.
So I've cut to the chase and compiled a list of my 16 favorite money rules of thumb.
These are, of course, just guidelines. By definition, rules of thumb aren't meant to be immutable laws or applicable in every situation. But hopefully these broad, easy-to-understand principals will at least give you a starting point for assessing what to do in your own financial situation.
Retirement, Part I: "Save 10% for basics, 15% for comfort, 20% to escape." This rule of thumb works pretty well if you start to save for retirement by your early 30s. Saving at least 10% of your income ensures you won't be eating pet food. Fifteen percent should get you a more comfortable living, while 20% gives you a shot at an early retirement (and yes, you get to count employer contributions as part of your percentage). Wait just a decade to start, though, and you'll need 15% for basics and 20% for comfort; an early retirement may not be in the cards. For a more customized estimate of how much you need to save, check out MSN Money's Retirement Planner.
Retirement, Part II: "Retirement money is for retirement; until then, keep your mitts off it." There's rarely a good reason to borrow against your retirement accounts, and almost never a reasonable excuse for cashing them out. Look elsewhere to find money to pay your debts or buy a home. Let your retirement money keep working for you undisturbed. Someday, you'll be glad you did.
Student loans: "Your total borrowing shouldn't exceed what you expect to make your first year out of school." Many graduates have learned to their chagrin that student lenders will gladly loan you far more money than you can comfortably repay. Students and parents need to put their own limits on how deeply they go into debt, or they could face a literal lifetime of student-loan payments. Read "How much college debt is too much?" for more details.
College savings: "Saving for retirement is more important, but try to put at least $25 a month per kid in a college savings plan." Your child can get student loans, but no one will lend you money for retirement. That's why retirement comes first. But contributing even a small amount each month will help reduce the amount of debt your child eventually incurs. Thanks to recent tax law changes and reductions in fees, 529 college-savings plans have emerged as the best way for most parents to save. To learn more, read "How Uncle Sam wants you to save for college."
Cars, Part I: "Buy used and drive it for at least 10 years." This one rule of thumb easily could save you tens of thousands of dollars over your lifetime compared with what you would pay buying cars new and owning them just five years. Not only will you buy half as many cars, but you'll avoid the 20% or so loss to depreciation that happens as soon as you drive a new car off the lot. Today's cars are better built and will last longer than ever before, so buying used isn't the gamble it used to be.
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Cars, Part II: "If you must borrow to buy a car, follow the 20/4/10 rule." Which means: Make a 20% down payment, don't borrow for more than four years and don't agree to a monthly payment that's more than 10% of your income -- or 8% if you plan to buy a home in the next few years. A substantial down payment ensures you'll have equity in your car when you drive off the lot -- which is important, since owing more on your car than its worth can leave you financially vulnerable if the vehicle is totaled or stolen. (Read "The real reason you're broke" and "Close the gap in your car insurance" for more details.) Limiting the loan term and monthly payment will keep you from overspending.
Cars, Part III: "To compute and compare the real monthly cost to buy, insure and operate a car, double the price tag and divide by 60." You can get more precise figures about how much a car will cost over five years by using Edmunds.com's "True Cost to Own" calculator. But this rule of thumb will help you determine if that car you think is affordable actually will be once all costs are factored in.
Credit cards: "If you carry a balance, look for the lowest rate. If you don't, get rewards at least equal to 1.5% of what you spend." Your primary goal if you carry credit card balances should be paying them off as quickly as possible. That means avoiding reward cards, which tend to have higher interest rates, in favor of the lowest-rate card for which you qualify, given your credit history. But if you already pay off your balances in full every month, you should look for cards that give you cash back or reward equal to 1.5% or more of your spending (read "People who charge everything" for more details). Sites like CardRatings.com and Bankrate.com can help you sort through the offers.
Debt repayment: "Pay off maxed-out cards first." When paying down credit card debt, the argument used to be between those who advocated paying the highest-rate card first (to save the most money) and those who argued for paying the smallest balance first (for a faster feeling of accomplishment that can motivate you to keep going). These days, though, you should first tackle any card that's close to its limit, since maxing out cards hurts your credit scores and can trigger penalty rates and fees.
Financial flexibility: "You need to be able to get your hands on cash or credit equal to three months' worth of expenses." Ideally, everybody would have at least three months' worth of expenses saved up in cash to serve as a cushion against job loss or other disasters. But saving that much money can take a while, as I wrote in "The $0 emergency fund," and many families have more important priorities to address first. Space on your credit cards and an unused home equity line of credit can be used as stand-ins for a real emergency fund until you can get around to saving the cash.
Insurance: "Cover yourself for catastrophic expenses, not the stuff you can cover out of pocket." Insurance isn't meant to cover the normal expenses of daily living, as I wrote in "3 costly myths about insurance." It's designed to bail you out when you face expenses so big they might otherwise wipe you out financially. That's why you want high limits on your policies -- but high deductibles, too.
Life insurance: "Those who need it typically need five to 10 times their income." Most people need to answer only two questions about insurance: "Do I need it?" and, if the answer is yes, "How much do I need?" You probably need life insurance if other people are financially dependent on you. You probably don't if you're single or your kids are grown. If you do need life insurance, the most important thing is to buy enough. Term or "pure" insurance is usually the way to go, since insurance that includes an investment component can be as much as 10 times more costly -- busting most families' budgets. The five- to 10-times-income rule is a pretty broad guideline, so you'll want to use MSN Money's Life Insurance Needs Estimator for a more precise fix.
Mortgages, Part I. "If you can't afford to buy the house using a 30-year fixed-rate mortgage, you can't afford the house." There are good reasons for choosing less traditional loans, but buying a house you couldn't otherwise afford isn't one of them. Too many people today are facing foreclosure because they used an adjustable or interest-only loan to buy too much house for their means. Read "Who's at most risk for foreclosure?" for the grim details.
Mortgages, Part II. "Fix the rate for at least as long as you plan to be in the home." Lenders, brokers or real-estate agents may tout the low, low payments of adjustable-rate loans, but sooner or later those payments will jump -- sometimes substantially. Protect your family and your investment by opting for a loan with a fixed-rate period that matches how long you expect to live there. If you're sure you'll move in five years, for example, a five-year hybrid is a good option. If you think you'll stay put for 10 years or more, you might just go for the certainty of the 30-year fixed.
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Mortgages, Part III: "You almost certainly have better things to do with your money than prepay a low-rate, deductible mortgage." People get excited about how much interest they can save by making extra mortgage payments. What they don't realize is that they can get a much better return elsewhere. Don't consider prepaying your mortgage until you're taking full advantage of your retirement savings options and have paid off all your other debt. Read "Don't rush to pay off that mortgage" for more details.
Priorities: "Retirement, then credit cards, then emergency fund." Your highest priority, typically, should be saving for retirement, since every dollar you fail to save today could cost you $10 or more in lost retirement income. (The younger you are, the more you'll lose by not tucking money away now.) Also, opportunities to get a 401(k) match or to fund an IRA or Roth IRA are typically "use it or lose it" propositions. Dispatching credit card debt should be your next highest priority, since it's probably accumulating at double-digit interest rates and reducing your financial flexibility (see above). Finally, an emergency fund equal to three to six months' worth of expenses can be a bulwark against the inevitable setbacks life sends us -- job loss, disability, illness, accidents, natural disasters. Having a pile of cash in a high-rate savings account can also do wonders for reducing your money anxieties.
Columns by Liz Pulliam Weston, the Web's most-read personal finance writer, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.
Published June 28, 2007
E-mail me at RealtorChris@msn.com