Making Cents: Debunking Rules of Thumb
By: John P. Napolitano, CFP®, CPA, PFS, MST
According to Wikipedia, “A rule of thumb is a principle with broad application that is not intended to be strictly accurate or reliable for every situation. It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination." This definition is spot on when it comes to financial issues as every situation is different and all conditions; economic, financial, health, family, career are subject to changes as the years pass by. Many of these changes are out of your control, but many are also within your control.
The first rule of thumb to disregard is how much money or cash flow you’ll need during retirement. I laugh when I hear that you’ll need X% of your most recent wages at retirement to make ends meet. How absurd is that? Your level of earnings have nothing to do with what you spend on living. What if your last few years were exceptionally profitable or terribly miserable?
The real answer with respect to retirement cash flow needs is to calculate how much it will cost to live your desired lifestyle. Then factor in wish list items like travel, grandkids and whatever else is on your bucket list to get a realistic forecast of what you’re likely to spend. Next, we’ll see if what you’d like to spend aligns with your abilities based on retirement income and savings. If it is, you’re good to go. But if your resources appear that they can’t support your desired lifestyle, then you have three options. You must either work longer, save more and or spend less.
A similar line of thinking can be applied to how much insurance you have. While working, disability insurance coverage should be one of the first areas you examine. Imagine no earnings from work with your current living expenses and then toss in additional medical expenses for good measure. Don’t rely on a guesstimate as to what percent of your income you’ll need to cover, calculate the precise amount and consider obtaining the proper coverage.
Same for life insurance. To hear someone say that X times salary should suffice is like saying you know exactly what will happen to dependents after the passing of a breadwinner, homemaker or caregiver. Make a plan to fully cover your family’s financial needs with the proper amount of life insurance or fully understand the lifestyle changes that you’re asking a survivor to make after a potential tragic event.
Rule of thumb for determining asset allocation may not be wise. Your age is a factor in calculating your risk tolerance, but so are all of the other moving parts of your financial life. Knowing what you must earn on your investments is critical. If you have excess, then an allocation with limited upside may be appropriate. On the other hand, you can afford to lose big, then perhaps an aggressive portfolio is best.
John P. Napolitano CFP®, CPA is CEO of US Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/ SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.