📰 30 Pieces of Household Finance Advice

(Original credit for these goes to David Laibson. I have added notes, so any blame goes to me!)

Saving

1. During periods of normal employment, your total savings target as a percentage of your pre-tax labor income should be:
   • 2.5% on the first $10,000 of income
   • 15% on the next $60,000 of income
   • 20% on the next $60,000 of income
   • 25% on all additional income
2. Bump up your savings rate (up to 10 percentage points more) when you can. By doing so, you can save less during financially challenging times.
3. If you will be supporting dependents (now or at some point in the future), think about how you’ll need to adjust your savings plan to accommodate this. You’ll save much less (maybe dissave) when you will be supporting dependents and you’ll need to save more when you’re not supporting dependents.
4. Adopt a catch-up philosophy: if you’ve fallen a bit behind this savings plan, no problem. It’s built to handle occasional setbacks. However, if you’ve fallen far behind, save more than the savings rates listed above, so you partially make up for the missing savings.
5. Prioritize saving categories (the green categories are tied and should be done simultaneously):
   • If you have a mortgage, and you aren’t under water, pay it (counting principal repayments, but not interest, as savings)
   • Take full advantage of the savers credit (if you are eligible)
   • Take full advantage of your employer’s retirement savings match (if you are lucky enough to have one; matching contributions count toward your total savings rate target)
   • Create a rainy day fund that is equal to 1/3 of your normal post-tax annual labor income (and hold this in a money market)
   • Build up a down-payment for buying a house (20% of the home value - hold this in a money market until deployed)
   • Save in a 401(k), 403(b), IRA, or some other defined contribution retirement account
   • If you save any money in a Roth account, multiply these saved dollars by 1.5 for the purposes of calculating your total savings rate

Investing

1. Invest retirement savings in a passive target date fund - sometimes called a lifecycle fund. It should have an expense ratio of less than 20 basis points and no loads. (Don’t try to time/play the market.)
   • Set it and forget it.
   • This is not an endorsement, but here are some well-known fund providers:
     1. https://investor.vanguard.com/investment-products/mutual-funds/target-retirement-funds
     2. https://www.blackrock.com/us/individual/investment-ideas/lifepath
2. Invest other savings in a money market fund that has an expense ratio of less than 20 basis points.
   • The above providers (and other providers) also offer low expense money market funds.
3. If you work with a financial planner, make certain that they are a fiduciary. Find out what fees they are charging you. (But keep in mind, that you likely don’t need a financial planner, if you follow the free advice listed here.)
4. Past returns have almost no predictive power for future returns and in many cases are negative predictors of future returns.

Debt

1. Buy a home with a 20% down-payment (wait to do this until you live in a place where you expect to stay for at least 7 years).
2. If interest rates fall by 2 percentage points or more from your mortgage origination rate, refinance your mortgage. In general, avoid cash-outs.
   • For an exact formula for optimal mortgage refinancing, see Agarwal, S., Driscoll, J. C., & Laibson, D. I. 2013. Optimal Mortgage Refinancing: A Closed‐Form Solution.Journal of Money, Credit and Banking, 45(4), 591-622.
3. When you buy a car, use up half of your rainy-day fund, and then borrow the rest of the money you need with an auto-loan.
4. Use a credit card that gives you at least 1% cash back (preferably 2%), or an equivalent value in points or miles.
5. Try to avoid credit card debt. Almost never use payday loans. (Your rainy-day fund - above - will enable you to mostly avoid credit card and payday debt.)

Misc

1. Buy life insurance, health insurance, automobile insurance, home-owner’s insurance and disability insurance (the last one is typically purchased from your employer as a group plan). Don’t buy other insurance, especially not extended warranties.
2. Ask for discounts. Ask for their best price. Ask if anyone else is paying a price lower than the price you are paying.
3. Shop around. Weaponize competition to your advantage and to the disadvantage of the firms selling you stuff.
4. Obtain commission discounts when you work with real estate brokers. If they won’t give you a discount, find another real estate broker. (If they tell you discounts are illegal, look up the law.)
5. Before you have kids (if you are going to have kids), create an estate plan including, durable power of attorney, will, living will, health care proxy.

Behavioral (Laibson’s area of expertise)

1. Financial things will go worse than you think (on average).
2. There are known unknowns and unknown unknowns. Think more about both of these categories. Discuss with friends, family, trusted advisors, etc…
3. Your financial services provider knows the mistakes you are making and is probably going to exploit them.
4. You will underperform relative to your own good intentions (e.g., procrastinate signing up for your employer’s 401(k) plan). Commit your actions ahead of time to overcome this propensity.
5. The only way to be good at something is either to be highly experienced, or to have someone with lots of experience helping you (with aligned interests).
6. Look for providers with a long and strong reputation for acting in the interests of their customers.
7. Try to keep the big picture in mind to avoid worrying about small loses (and thereby letting loss aversion rule/ruin your life).

Retirement

1. Remember that long-term care is expensive and is not covered by Medicare. Keep savings set aside for this expense (ballpark cost is $100,000 per year per person). If you run out of money, Medicaid will cover a far less comfortable version of long-term care.
2. When you retire, withdraw your (annual) required minimum distribution (RMD) from your retirement savings plan and consume the (after-tax) value of those withdrawals along with your other annuity payments (e.g., Social Security).

Meta-advice

1. The financial world is constantly changing. You’ll need to continuously update your financial strategy as new products, regulations, and challenges emerge.
2. Ignore this lecture.
   • The advice you just received is oversimplified (which makes it actionable).
   • Be skeptical of anyone offering financial advice.
   • Hmmm.