The title of this piece is “guaranteed” to make financial regulators hyperventilate and plaintiff’s attorneys salivate, but I think you will find it hyperbole-free. Of course, as Benjamin Franklin famously observed, “in this world nothing can be said to be certain, except death and taxes” but I think these rules come very, very close.
Before we get to the rules, two initial items need to be clarified. First, we need to define “financial success.” As I have noted before (here) financial success can be defined as simply having more than you need. With these rules I’m thinking more along the lines of lifetime consumption smoothing (which Milton Friedman, among other economists, showed maximizes happiness). Second, these rules get you “guaranteed” and they may seem extreme. Many people will be successful doing less than suggested here, but the further you are from following these rules, the less certain your financial success.
So on to the rules…
The first rule is to start young. These rules will help at any age, but for “guaranteed” financial success starting young is imperative.
The second rule is to maximize all tax-advantaged retirement plans such as your 401(k), 403(b), SEP, SIMPLE, IRA, Roth IRA, etc. There are two pieces to this, 1) make the maximum permitted contributions while working, and 2) take only the required minimum distributions upon retirement. (If you don’t have access to a plan through your employer, or your income is high, you may need to save in a taxable account as well. The idea is to have about a 25% savings rate – just for retirement, other saving, such as for children’s higher education, would be in addition to that. Note that in reaching 25%, principal payments on a mortgage count as savings, as do Social Security contributions.)
The third rule is to never borrow money for a depreciating asset. A depreciating asset is one that declines in value over time such as a car, consumer goods, etc. For this rule it is easier to explain the things that it is acceptable to borrow for. I think there are only three:
- A prudent education. Prudent in two ways – the field of study and the cost. For example, borrowing $60,000/year to go to an exclusive private university for a bachelor’s degree in theater arts is likely to be a terrible investment for most students. Borrowing $20,000 to go to the state university for an engineering degree is likely to be a very good investment for most students. Obviously not borrowing at all is optimal, but if it is the only way to get the degree it can be a good use of debt.
- A primary residence. Obviously homes can decline in value, but assuming you make a reasonable purchase (purchase price no more than 2x gross income) this can be a “good” debt.
- A low-risk investment. Many businesses appropriately borrow money to fund expansion or for seasonal working capital. Borrowing conservatively to purchase a rental property can be prudent as well.
The fourth rule is to hedge all the risks you reasonably can. This would include buying appropriate amounts of life, health, and disability insurance, as well as liability insurance. Also, avoid concentrated stock and business investments and further diversify your portfolio between stocks and bonds, domestic and foreign holdings, etc. Finally, realize that divorce is one of the biggest risks of all.
It may be possible to follow these four rules and still end up a financial failure, but I can’t think of a way.