Smart Money Rules

We’ve all heard those, rules about how to spend and save money that influence the way we plan for the future. But are they true??

Close credit accounts that you no longer use.

Assuming your history with those accounts is good, cut up the cards, but keep the accounts open so you do not hurt your credit score.

When lenders decide whether to extend credit, they look at how much of your available credit you are already using-poetically called your utilization ratio.

Let’s say you have five credit cards, each with a $10,000 limit, and your total balance is $6000. That gives you a utilization ratio of 12 per cent-not bad, in the eyes of lenders. But, if you close four of those accounts, your ratio suddenly jumps to 60 per cent-not good.” You have not borrowed an additional cent, but on paper it looks as if you are closer to being over extended,” says Craig Watts of Fair Isaac, the company that developed the credit rating system. Ideally, you should keep your utilization ratio below 50 per cent, says Maxine Sweet of the credit reporting company Experian.

Buying a car is always cheaper than leasing.     

It depends on your driving habit, the car you are considering and what else you could do with the money.

One big benefit of leasing is that you can keep more money in your pocket. You do not need a down payment, and your monthly note is lower-nearly half as much on some luxury models. Invest the difference, and you could come out ahead.

For a fee, you can get software to compare leasing cost to buying costs on the internet.

In general, if you buy a new vehicle soon as your old one is paid off, leasing can save your money. Buying is a better deal if you tend to hang on to your car.

Set up an emergency fund to cover three to six months of expenses.

You might be able to get by with a small stash-say, two or three months of expenses-as long as you have a low interest home equity line of credit.

When calculating your expenses, do not forget to include the deductible on your car or house owner’s insurance policy, which ever amount is higher.

The idea is to keep enough cash on hand so that you do not have to sell shares or rack up credit card debt if you have an emergency-but not so much that you lose out on the higher returns you can earn on longer term investments.

Emergency money need to be safe and accessible, which means keeping it in a bank money-market account or a money-market fund with cheque-writing privileges.

Your life insurance cover age should equal six times your annual income.

A better rule is eight to ten times of your annual income, says Robert Bland, the chief executive officer of Insure.com. You will need the higher amount if you have young children and are also the sole breadwinner. If both you and your spouse work and you have saved enough to cover most of your kids’ university bills, the lower figure may be sufficient.

Add up your expenses, subtract sources of income available after your death-and buy enough life insurance to make up the difference. Use the “how much life insurance do I need?” calculator at Kiplinger.com/tools. Do not overlook the value of a stay at home spouse. In the event of his or her death, your expenses for child care and other services could increase significantly.

Don’t buy a house that costs more than 2.5 times your annual income.

Good luck even finding such a house in many major cities around the world. What really counts is your monthly payment, not the value of your house. And that is affected by your down payment and the terms of your loan.

“If you have saved a substantial amount of  money, benefited from a windfall, or taken a lot of equity out of your previous house, you may be able to live with the payments on a more expansive house,” says certified financial planner Barbara Steinmetz.

Pete Bonnikson, senior vice president of mortgage operations for E-Loan, an online customer lender, says a better rule of thumb is to make sure your monthly mortgage obligation including principal, interest, taxes and hazard insurance does not exceed 36 per cent of your monthly gross income.

Monthly payments on installment debt should not exceed 20 per cent of your take home pay.

That is too narrow a snapshot.

After all, prospective lender look at all of your current debt and so should you. That includes installment debt, such as car loan and credit card balances, plus your mortgage.

A better rule is that your total monthly debt payments should not exceed 40 per cent of your monthly income, says Bob Walters, chief economist for Quicken Loans.

You can retire comfortably on the nest egg of $1 million.

A million bucks isn’t what it used to be. But it may be enough if you have paid of your mortgage, live in a low cost area, and have a comfortable pension.

“The 1 million will safely generate $40,000 in the first year, and thereafter annual three per cent inflation increase,” says Stuart Ritter, a financial planner with T.Rowe Price. “So, if you can live on that, plus your other income sources, then it is enough. If you can’t, it isn’t.”

First, figure out how much money you are likely to spend annually in retirement; then work backward to calculate how large a fund you will need.

Don’t buy long term care insurance if your annual income is less than $30,000 or you have more than $1 million in assets.

This rule makes sense on how low end. Expert recommended that you have at least $25,000 to $35,000 in annual retirement income and $75,000in assets before considering long term care insurance. If your income and assets fall significantly, you might qualify for social welfare benefits if you needed care. Still, if you can afford the premiums, long term care insurance is preferable to relying on social welfare or your family.

Private insurance gives you significantly more choice. The $1 million cut off on the upper and doesn’t make the grade, though. In theory, if you have that much in assets, you can afford long term care. But many people would rather buy insurance: it alleviates the concern that caring for one spouse could deplete a couple’s assets. And it protect those assets for their heirs.