A lot of financial advice is framed as things you should never do. Here are a few â€œdonâ€™tsâ€ youâ€™ve probably heard more than once:
- Donâ€™t borrow money from your retirement plan. For instance, see 4 Reasons You Should Never, Ever Take a 401(k) Loan.
- Donâ€™t take a loan or use your credit cards to fund your dream toâ€¦ [fill in the blank — start a business, go back to school, relocate, etc.]
- Donâ€™t borrow money from (or lend money to) family or friends. Hereâ€™s a quick take from financial advisor Dave Ramsey on why this is always a bad idea.
- Donâ€™t accept a lower salary when changing jobs.
- Donâ€™t rent when you can buy. For instance, David Bach, co-founder of AE Wealth Management, believes that millennials should buy, not rent.
Do all these â€œdonâ€™tsâ€ and others like them really apply to every person and every situation?
Of course not.
But you should understand why such rules exist, and then assess what makes the most sense for you.
Received Wisdom and Rules of Thumb
It helps to view most financial rules as â€œrules of thumbâ€ and then determine if they apply to you.
Many rules are received wisdom passed down through generations. Sometimes they donâ€™t apply as much as they used to. For instance, the â€œruleâ€ about never renting when you can buy is based, in part, on the premise that money spent on rent is wasted when it could be building up equity.
However, we all know of many situations where renting makes better financial sense, depending on the housing market and personal situations.
â€œYou should never do Xâ€ probably means â€œvery rarely is X a good idea, but occasionally it might be.â€
That wiggle room in the rules is important. At the same time, a rule that is widely touted by financial advisors (and not just your Uncle Joe) probably does make sense nine times out of 10 â€“ or maybe even 99 times out of 100.
Regret-Free Rule Breaking
Your goal should be no regrets. This means fully understanding the potential risks of any financial decision â€“ especially rule-breaking decisions â€“ and weighing those risks against your goals.
For instance, letâ€™s look at borrowing money from a 401(k) or IRA. A recent study by TIAA-CREF found that nearly one-third of Americans had taken a loan from their retirement plan savings. So even though weâ€™re frequently warned not to do it, itâ€™s obviously something people choose to do.
Furthermore, the people borrowing against retirement savings had strong financial reasons for doing so. Forty-six percent borrowed to pay off debt and 35 percent did so for an emergency expenditure.
However, the same study also found 44 percent of those who had borrowed from their retirement plan regretted the decision. Furthermore, even among those who did not express regret about the decision, more than one in five said they would not do it again in the future.
So even if you have good reasons for making this common â€œdonâ€™tâ€ a â€œdoâ€, be aware thereâ€™s a high chance you may regret the decision when you see the long-term impact on your retirement savings. Worse yet, you may find you are unable to repay the loan. If that happens, you will end up owing early withdrawal fees and taxes on top of depleting savings intended for your retirement.
Before deciding a donâ€™t is a do for you, be sure you fully understand the potential downsides of your decision. Know why youâ€™re breaking a rule. Know what breaking the rule could cost you.
7 Ways to Break Financial Rules
Even if most financial donâ€™ts are really just rules of thumb, they didnâ€™t arise out of nowhere. Treat such rules as â€œcautionâ€ signs that mean you need to slow down and think carefully about your choices.
To that end, here are seven rules for breaking the rules.
1. Donâ€™t be a rebel without a cause.
Donâ€™t approach rules with a â€œrules are meant to be brokenâ€ attitude. Try not to ignore financial rules of thumb because â€œeverybody does itâ€ or â€œmy cousin did it.â€ You need a logical justification that makes sense for your financial goals, not just a rationalization. You should fully understand the costs and risks of your financial decisions, and this is especially true when you believe a â€œdonâ€™tâ€ could be a â€œdoâ€ for you
2. Always have a financial plan.
If you donâ€™t have a plan, your financial decisions arenâ€™t part of a bigger picture. How will your decision to break a rule impact your long-term goals? Will it support your plan? Could it derail your plan?
3. Have contingency plans to address the “what ifs” involved with every big financial decision.
Part of financial planning is creating a safety net for you and your loved ones. For instance, another factor informing the rule about buying rather than renting is that when you rent, your situation is inherently less stable. You have less control over your future.
What if your rent goes up to more than you can afford? What if the building or house you live in is sold and you are forced to move? What if a fire or natural disaster makes your rental uninhabitable?Â First of all, you can mitigate some of the risk by having renters insurance, which is affordable. If you choose to rent, then also be sure you have an emergency fund that would allow you to move on short notice.
Contingency plans are also important if you decide to borrow money from family or friends. Imagine your parents give you a large, open-ended loan to help you launch a business. The plan is you will repay them over time, as you are able, and your familyâ€™s expectation is you will help support your parents and be available to help with caregiving as they get older.Â What if the worst happens and you die before your parents? What if this happens before the loan is repaid? Your parents wonâ€™t have the money they loaned you and you wonâ€™t be there to help care for them.
To mitigate these risks, it would be smart to have life insurance naming your parents as beneficiaries, with enough coverage to repay what you owe them, plus additional funds to help with caregiving. Life insurance is an affordable investment that addresses some of the biggest risks that come with taking a large loan from someone you love.
4. Be brutally honest with yourself.
Thereâ€™s probably not a person in the world who doesnâ€™t have regrets about past financial choices. Take a hard look at your own past behavior as a good predictor of the future. If youâ€™ve had a hard time paying down debt in the past and now youâ€™re considering borrowing from your 401K, what makes you think this time will be any different? If youâ€™ve borrowed money from a friend or loaned money to a friend and ended up ruining a friendship, can you be sure this time will have a better outcome? And if youâ€™re always struggling with finances, then sticking to some rules before you break any rules might be the most radical thing you can do.
5. Be a rule maker before you’re a rule breaker.
If you have sound financial rules for yourself and follow them, then when you want to break a rule, you will be in a stronger position to deal with any risks or negative impact. For instance, if you have a long-term financial plan that includes living within your means, sufficient emergency savings and a solid foundation for your retirement savings, then if you decide to accept a lower salary in order to change career paths or pursue a dream job, you can make that decision without triggering a financial crisis.
For some inspiration, check out this account from a woman who embraced five financial rules to live by in her 20s. By sticking to those rules, she eventually put herself in a position to break them all and pursue some big dream dreams. Her five financial rules eventually led to financial freedom.
6. Explore all your options.
Sometimes weâ€™re tempted to break a rule out of desperation or because itâ€™s the path of least resistance. Take a step back. If youâ€™re going to ignore a financial rule of thumb, donâ€™t do it impulsively. It should always be a carefully considered decision. Be sure to compare your options and understand the costs and risks. Perhaps there are solutions you havenâ€™t considered. Or maybe you can combine two â€œdonâ€™tsâ€ into a â€œdoâ€ that provides a more acceptable level of risk. Be creative and resourceful. For instance, you are trying to raise money to launch a new business, perhaps you can ask family and friends to support you through a Kickstarter campaign, where they donate money to support your idea, rather than lending you money you may not be able to pay back.
7. Know when to seek expert advice.
An experienced financial advisor can help you follow through on rule number six by suggesting solutions and options you may not know about.
Most importantly, if a financial decision involves a level of risk that could really hurt you or those you love â€“ the kind of risk that could lead to serious short-term or long-term consequences â€“ then you should definitely get some expert advice before proceeding.
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