Personal finance rules you should know by heart

There are tons of personal finance tips, tricks, and rules that can greatly improve your financial well-being. However, some are more important than others.

Here are four personal finance rules in particular that are extremely important to your financial health, both now and in the future.

Avoid credit card debt — in most cases

Most people realize that credit card debt is a form of “bad debt,” but they carry it anyway. About 46% of U.S. households carry credit card debt, and among those that do, the average balance is $15,654, according to personal finance website NerdWallet.

A general personal finance rule is to avoid credit card debt at all costs. It’s typically better to finance something with a personal loan, home equity loan, or even a 401(k) loan than it is to pay double-digit credit card interest rates.

The exception is if you have credit card debt at little or no interest and are capable of paying it off in full before a big interest rate kicks in. For example, when my wife and I bought our house, we bought our furniture using a store credit card’s 60-month deferred interest offer and paid the balance off before the promotional period expired.

However, it’s important to beware of how deferred interest financing offers work. If we hadn’t been able to pay the entire balance within 60 months, we would have been hit with a bill for all of the interest that would have accumulated the entire time at the card’s standard 29.99% rate.

Save and invest at least 10% of what you earn for retirement

One of the most common questions I get asked by friends and family is “How much should I be putting in my 401(k)?” The short answer — 10% of your income is a good target.

For a little more colour, this applies if you’re saving for retirement in an IRA, 403(b), 457, Thrift Savings Plan, or any other type of retirement account. It also does not include any employer matching contributions or any investments you make in standard (taxable) brokerage accounts. In other words, you should earmark 10% of your pre-tax compensation for your retirement savings.

This may seem like a lot, especially if you’re contributing, say, 5% now. However, you don’t need to get there right away. Try increasing your contribution rate by 1% per year until you get to 10%. Or try increasing your contribution rate whenever you get a raise.

And of course, even more than 10% is definitely better. It’s always a smart idea to over-prepare for retirement.

Contribute to an emergency fund

It’s tough to overemphasize the importance of having a retirement fund. A recent Bankrate.com report found that 61% of Americans would be unable to cover a $1,000 emergency expense from their savings.

Experts generally suggest that an ideal emergency fund has six months’ worth of your living expenses in a readily accessible account, but this can be a lot of money. Don’t be discouraged.

Instead, if you’re one of the majority of Americans who doesn’t have a big savings account, set a realistic short-term goal, like $500 or $1,000 — something you could reasonably achieve in a year or so. My suggestion is to divide this goal by the number of times you get paid each year, and set up an automatic transfer. If you can get to $1,000, you’ll already be better equipped to handle an emergency than most people.

Live below your means

Many people believe that if they don’t spend more than they make, they’ll end up in good financial shape. I believe in going a step further and making a conscious effort to spend less than you make, even after accounting for savings.

In other words, don’t buy a more expensive car just because you can afford it if a less-expensive model suits your needs and your taste just fine. If you take home $5,000 per month and save $1,000 for retirement and unforeseen expenses, make it your goal to spend substantially less than the other $4,000.

Just a starting point

Of course, these aren’t the only personal finance rules you should keep in mind, but they are certainly some of the most important ones. If you avoid credit card debt, save 10% of your income for retirement, maintain a substantial emergency fund, and live below your means, you’ll be on your way to financial independence.

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Courtesy:  Motley Fool