If you’ve ever received financial advice, you’re likely to see a lot of the same traditional advice over and over. That’s because the world of personal finance can be esoteric and even scary, and the experts dispensing that advice want to impart the strategies that work the best for the majority of people.
Still, personal finance is, well, personal. With millions of individual financial situations existing, there are few hard and fast financial rules that can’t be bent — or even broken. Sure, there are a few ironclad ones: Don’t evade taxes, and try to build emergency savings, if you can. But most of the money advice that you encounter will require you to consider whether it applies to your situation.
Read on for three financial rules you’ll encounter frequently, and when financial planners say it could make sense for you to break them.
‘Pay down high-interest rate debt first’
Why it’s a rule: The math works out. If you have multiple debts, the money you owe on the loans with the highest interest rates is compounding at the fastest rate. By paying off those loans first, you’ll save more money in the long run and pay down your debt faster.
When to consider breaking it: Getting out of debt is hard. And if that’s your goal, doing what’s mathematically right may not be as important as keeping yourself mentally on track.
Video by David Fang
“Let’s be honest, we’d like to keep our emotions out of money, but for most people that’s not possible. So we have to consider the emotional and behavioral impacts of choices,” says Michelle Petrowski, a certified financial planner and founder of Being in Abundance Wealth Management in Phoenix, Arizona.
For some clients, Petrowski recommends the so-called “snowball method” of paying down debt wherein a debtor makes minimum payments on all accounts but prioritizes the loans with the smallest balances first. Research backs her up: Several studies have found that knocking out small debts first helps motivate borrowers to keep chipping away at their balances.
“For many, [this method] makes more sense than traditional advice of paying down the high-interest-rate debt first,” she says. “Sure, the numbers are better on the latter choice, paying less interest, but clients need an emotional win, a reason to stick to the plan, and often the ‘snowball’ method provides just that.”
‘You shouldn’t actually want a tax refund’
Why it’s a rule: If you get a tax refund, it’s often the result of your employer withholding more than you owe in taxes. Getting a refund can feel like a windfall, but in essence the government is just giving you back money that was always yours.
Because you couldn’t do anything with the money in the meantime, tax experts often describe a refund as “an interest-free loan to the government.” If you do expect to get a refund, tax experts suggest you adjust your withholding by submitting a new W-4 form with your employer’s HR department in order to keep more money in your paycheck.
Video by David Fang
When to consider breaking it: Look at what you’re doing with the money you earn now and ask yourself what you’d do with a larger paycheck each month. If the answer is “spend more,” you might be better off having your employer set that extra money aside for you.
“If you work it to where you have a huge refund, that can be a forced savings methodology,” says Vidal Peoples, a financial advisor at Strategies for Wealth in New York City. “And you may think, ‘I’m my biggest threat to my savings.’ If they put us in a banquet hall at the Four Seasons filled with really nice food, we’re going to be inclined to eat.”
The average tax refund for 2020 was $2,827, according to National Taxpayer Advocate — plenty for you to put to good use, says Peoples. “I’d want my clients to be using that refund check to build assets and retire debt,” he says.
‘Aim to max out your traditional 401(k)’
Why it’s a rule: Contributions to workplace retirement accounts are the type of automatic savings that financial advisors love. The money comes right out of your paycheck and into a tax-advantaged retirement savings portfolio. The account will compound over time, and the more you contribute now, the likelier you are to be wealthy in retirement.
When to consider breaking it: If you’re focusing all of your retirement savings on a traditional 401(k) plan, you could be missing out on serious tax advantages, namely the ones that come with a Roth IRA. Unlike traditional 401(k) plans, for which pre-tax contributions are deductible on your tax return, Roth accounts (which can include 401(k)s depending on your employer) are funded with money you’ve already paid taxes on.
Contributions to Roths grow tax-free in your account, and you won’t owe a penny to the IRS when you withdraw your funds in retirement, provided you’re at least age 59 1/2 and have held the account for at least five tax years.
“The other benefit to a Roth IRA is that you can always take out your contributions at any time without income taxes or penalties,” says Thomas Scanlon, a certified financial planner at Raymond James in Manchester, Connecticut. “If a young person puts $6,000 into a Roth IRA for a decade, they could withdraw this, if they needed it, as a down payment on a house.”
Instead of contributing as much as you can to your 401(k), contribute only as much as you need to earn any matching contribution from your employer, he suggests. From there, focus on contributing as much as you can to a Roth IRA, he says, provided you meet the income requirements: “This sets you up for a great retirement.”
The article “3 Traditional Rules for Building Wealth, and When Experts Suggest You Break Them” originally published on Grow (CNBC + Acorns).