6 Numbers for Financial Success
Successful money management is impossible if you don't know what financial goals to set. Here, you'll find expert-recommended financial targets that help you save and spend smarter.
28% = The Share of Your Pretax Monthly Income That Should Go Toward Housing Costs
Why this target: During the housing boom, many people laid out unrealistic amounts of their gross income (sometimes 45 percent or higher) for their monthly mortgage payment, real estate taxes, and home owner’s insurance. And everyone knows how that turned out (see: foreclosure crisis). These days many banks have tighter lending standards, meaning they may not lend to someone whose housing payments are liable to exceed the benchmark of about 28 percent. (Some experts say that up to 38 percent of pretax monthly income is a reasonable target.) If you want a home that takes you over this limit, it won’t be easy to get a loan: Typically, you’ll need a minimum credit score of around 740 and a down payment of 10 percent or more, says Carolyn Warren, the author of Homebuyers Beware ($20, amazon.com).
How to hit it: Use a mortgage calculator to estimate your costs (try the one at Bankrate.com). If you’re just over the 28 percent mark, shrink your monthly costs by making a larger down payment and signing up for a high-deductible home owner’s policy, which could reduce your premiums by 25 percent. You could also lower your mortgage interest rate by paying “points” to a lender up front. (A point is 1 percent of the total loan.) You’ll pay heftier closing costs, but your monthly outlay will be smaller.
120 – Your Age = The Maximum Percentage of Your Retirement Savings That Should Be in Stocks or Stock Mutual Funds
Why this target: Before the recent recession, many financial planners used 100 minus your age as a rule of thumb. So why the increase? Generally, people need more exposure to stocks to recoup what they lost during the market crash (since stocks have historically outperformed other investments). That said, stocks can be risky, so “the closer you are to needing the money—say, for retirement—the less you should gamble with it,” says Jim Holtzman, a Pittsburgh-based certified financial planner at Legend Financial Advisors. That’s why this formula becomes more conservative year by year, as you get closer to cashing out.
How to hit it: Rebalance your retirement portfolio annually to adjust your stock/bond mix. Or consider investing in a target-date mutual fund that does all that work for you, gradually shifting money out of stocks and into bonds and cash as you get older. Look for a fund with low fees that sticks close to this formula. One example: the Vanguard Target Retirement 2040 fund (vanguard.com). Designed for people planning to retire between 2038 and 2042, it currently allocates approximately 90 percent of its assets to stocks.
5% = The Maximum Percentage of Your Take-Home Pay That You Should Owe to Credit-Card Companies
Why this target: In an ideal world, you would pay off your credit card every month. Realistically, however, you probably carry a balance; the average American household has $15,799 in credit-card debt, according to CreditCards.com, an education site. Next to overdue taxes, this is the most expensive money you can owe—the average interest rate is 14.4 percent, according to a recent Bankrate survey. And the bigger the debt, the deeper the financial hole you’ll find yourself in. That’s why experts suggest you work to get your credit-card debt under 5 percent of your net pay—meaning, if you take home about $2,000 a month, your revolving card debt should not exceed $100.
How to hit it: If you owe a substantial amount, consider making double or even triple the minimum payment until you dip under the 5 percent mark. If you have several cards, try to pay off the one with the lowest balance, then move to the one with the second-highest balance, and so on. “The immediate gratification of eliminating one debt entirely will make you feel as if you can tackle the other cards,” says Ellen Holden, a certified financial planner based in Los Angeles. If you can, sign up for a card with a 0 percent balance-transfer incentive (start your search at CardRatings.com). But be sure to pay on time every month or the promotional interest rate will increase.
10% = The Minimum Amount of Your Pretax Income to Save for Retirement
Why this target: Chances are, you want to maintain your current living standard during your leisure years. First the bad news: Experts used to say that you would need 60 to 80 percent of your current working income for your retirement years; now they recommend 100 percent, due to rising healthcare costs. The good news: It is possible to save that much—as long as you regularly tithe your own earnings. Assuming you began saving at age 25, aim to save 10 percent of every paycheck now. If you began saving at age 35, you’ll need to put aside as much as 20 percent of your annual income, says Sheryl Garrett, the founder of the Garrett Planning Network of fee-only financial advisers, based in Shawnee Mission, Kansas. (Use the retirement calculator at Fidelity.com to compute your exact savings goal.)
How to hit it: Sock as much as you can into your 401(k) plan. (The annual maximum is $16,500.) If you can afford to save more, open an IRA, into which you can put up to $5,000 a year. Over age 50 and started saving late? You can make an extra $5,500 in catch-up contributions annually to a 401(k) plan and an extra $1,000 to an IRA. If you’re self-employed, set up an individual 401(k) plan through any major mutual-fund company, brokerage house, or discount broker (like Charles Schwab or E*Trade) at no cost.
1 = The Number of Times a Year You Should Review Your Retirement Portfolio
Why this target: Saving for your post-job life is a long-term goal, so you don’t need to tweak your investment choices often. (Yes, that applies even if your golden years are fast approaching.) And you certainly shouldn’t try to time the market—that is, buy and sell according to whether the Dow is up or down, since experts say it’s nearly impossible to succeed at that.
How to hit it: Pick a month to review your IRA and 401(k) allocations. For many, January is best, as that’s when year-end statements arrive, so all the paperwork is at your fingertips. You might not realize this, but a market swing in either direction could change your allocations. The annual review also lets you do a gut check on your risk tolerance. Although you should try to stick with the 120-minus-your-age guideline, it’s OK to amend your allocations slightly if you’re losing sleep. Also use the check-in as a time to review your retirement plan in relation to your overall financial situation. See if you can increase your savings contributions, even if by only 1 percent, says Garrett.
10 x Your Gross Income = The Minimum Amount of Life Insurance You Should Buy
Why this target: Estimating how much money your surviving family members will need at some point in the (hopefully distant) future is a real head-scratcher. And most people lowball the number—sometimes to avoid higher premiums. “Fortunately, buying the right amount of coverage is surprisingly affordable,” says Thomas Henske, a partner at the wealth-management firm Lenox Advisors, in New York City.
How to hit it: Start with the free or low-cost group term life insurance you might receive as part of your benefits at work. But don’t stop there: Either increase that amount by paying a premium or get a better deal by supplementing the coverage on your own, says Henske. If you’re 40 and in good health, for example, you can buy $1 million of term coverage for about $225 a year. (Term life insurance covers you for a specified period—say, 15 years—and is less expensive annually than whole life insurance, which covers you for your entire life and has an investment component.) To find a plan, use an independent agent who will shop various companies for the best rate. (Find one at TrustedChoice.com.) If you can’t afford the premium for insurance that fits this benchmark, buy as much coverage as you feel you can afford.