10 Financial Rules of Thumb You Don’t Have to Follow

Financial plans can be overwhelming to conceptualize, create, and cultivate. So to help make sense of them, most people turn to goal-setting principles or easy rules of thumb.

But these frameworks can have their limitations.

A rule of thumb provides a rough outline of how to think about something, but it isn’t a silver bullet. Your life and situation are unique, and so are the practices that are best suited for them.

The idea of goals could also be reframed. You know your financial goals—maybe one is buying a house or paying for a child’s education. But think about those goals as more of a means than an end. Why do you want to buy a house? It’s not just so you can say you’re a homeowner. It’s because you want stability, security, and a place to raise your family.

By viewing your financial goals as a way to manifest your values, you can better identify what you need to do to achieve them.

Use this guide to unpack which rules of thumb apply to you and which ones you can ignore.

Rule of Thumb #1: Delay Social Security as Long as Possible

What to know:

You can start collecting Social Security at 62. The age thresholds for higher Social Security payouts vary depending on the year you were born: If you were born in 1960 or later, you can get a higher monthly check if you start at age 67, and an even higher one if you wait until 70.

Consider what delaying Social Security would mean for other aspects of your life. Would working until you’re 70 mean sacrificing your personal goals?

When to follow it:

• You’re currently working and earning the most you’ve ever been. Since your Social Security payout is based on your lifetime average income, working a couple more years at a higher salary can help increase your monthly payment.
• The delay will be a good motivator. Consider if this timeline will help motivate you to save more in your other retirement accounts or to work longer.

When to break it:

• You don’t have a long life expectancy. The added lifetime benefit of delaying Social Security to age 70 is clear if you live to 90, but not if you live to be 75. Though no one knows how long they’ll live, even a rough approximation can be helpful for increasing your lifetime benefit.
• It’s not feasible to work to 70 and you don’t have other retirement assets available. You may need to pull other financial levers, but your Social Security payout can still be a key part of an early retirement plan.
• Your spouse earns more than you. Use your lower Social Security paycheck to tide yourselves over, and delay collecting the higher-earning spouse’s Social Security. Maximizing the higher amount will increase the eventual benefit for the couple.

Rule of Thumb #2: Never Take a Loan From Your 401(k)

What to know:

Withdrawing funds from your 401(k) before retirement age (59½) incurs a 10% penalty, unless it’s an “emergency withdrawal.” And if you lose or leave your job, you’ll have to repay the loan in a short period of time (typically 60 or 90 days), or the remaining balance will be subject to the 10% penalty and standard income taxes.

Understand how each of your accounts supports your goals. Ensure that you’re putting funds toward their intended purpose and only deviate when it’s absolutely needed.

When to follow it:

• Your basic needs are covered. A 401(k) loan is not meant to afford a higher mortgage payment or fund a vacation. Withdrawals mean you’ll have less saved for the future and miss out on compounding.
• You have the means to create an emergency fund. Consider a savings account or a money market fund for your emergency fund, which is the gold standard for covering unexpected expenses.

When to break it:

• You need cash for a specific, one-time need. When necessary, your 401(k) can provide a one-time cash infusion to fund an expense like rent or a mortgage payment to prevent eviction or foreclosure.
• Your only other option is a loan with a third party. Though you’ll carry the burden of interest on the 401(k) loan, you’ll pay it into your account rather than a bank.
• You’re carrying high-interest credit card debt. The average credit card plan’s APR is 15.78%. So you may choose to absorb your 401(k) loan’s penalty and rid yourself of the double-digit credit-card interest—especially since you’re paying the interest on the 401(k) loan to yourself.

Rule of Thumb #3: Prioritize Paying Down Your Mortgage

What to know:

Mortgage debt is most Americans’ biggest single form of debt, with student loans in a distant second.

For many, paying off that enormous debt and owning a home outright is an important source of comfort. Think about how meaningful the security of homeownership is to your personal goals.

When to follow it:

• You’re close to retirement. If you have more conservative investments, the returns you’d see on new contributions probably won’t exceed your mortgage rate—and you’d more effectively reduce your fixed expenses by paying off your home.
• You have private mortgage insurance. This is typically required for borrowers with less than 20% equity in their homes, and most individuals would benefit from paying down their mortgage enough to eliminate the extra expense.

When to break it:

• Your mortgage interest rate is lower than bond and cash yields. If you have an older home loan with a low interest rate, today’s bond and cash yields could exceed the “return” you’d earn from mortgage paydown.
• You have longer until retirement. Though stock returns are never guaranteed, history suggests that stock market investing will outperform mortgage rates over several decades.
• Carrying a mortgage would be a boon to your taxes. Factor in all the tax implications. Though you’re likely getting a tax break from carrying your mortgage, recent changes to the tax code limit the power of this benefit. Still, doing so can help your overall tax situation if, for example, it allows you to make higher pretax contributions to your 401(k).

Rule of Thumb #4: Prioritize Diversification in Investing

What to know:

It makes sense to have a plan for navigating different market environments. For example, Morningstar portfolio specialist Amy Arnott explains, large-cap stocks perform best during economic growth and bonds during low inflation.

But diversification should help you feel like your goals are within reach, not make you worry about missing every opportunity.

When to follow it:

• You’re investing over a shorter period. Diversification is the best way to ensure that even if certain asset classes experience losses that may not recover within your time horizon, you’ll still come out ahead.
• You’re only investing in single stocks. You can reduce stock-specific risk by investing in equity funds that own a basket of securities, but it’s even better to use funds that own a variety of asset classes to make up for potential net losses in the stock market.

When to break it:

• You’ve been taking the same approach to diversification for a while. Correlations between asset classes change, and one mix of investments won’t behave the same in every market environment.
• You’re adding asset classes that don’t serve another purpose. Investments like real estate might seem great because they don’t move in tandem with the broader markets. But their lows can be major, and that can be hard to stick with.
• It’s getting too complicated. Morningstar research shows that 87% of the time, a 60/40 portfolio has better risk-adjusted returns than a portfolio with exposure to 11 asset classes. Diversification is important, but you don’t necessarily need an array of niche asset classes to see its benefits.

Rule of Thumb #5: Buy the Dip

What to know:

“Buy low, sell high” is a core tenet of investing, but don’t wait for the markets to sink to get started—it’s typically a good idea to start investing sooner rather than later.

Consider what you can do to start working toward your goals today.

When to follow it:

• The Fed has begun cutting interest rates. Over the past 70 years, there have been three bear markets in which investors benefited by buying stocks that were headed down but not at the bottom yet. Though there’s no guarantee that this trend will continue, the common thread in these past cases was that interest rates were also headed down.
• You have a crystal ball. Markets rarely hit bottom in one fell swoop; they tend to take jagged paths to the bottom and the top. Buying as the dip starts often ends up amplifying losses more than it results in long-term gains.

When to break it:

• You’re new to investing. Don’t wait for a dip to start investing. Morningstar director of personal finance Christine Benz notes that, for most new investors, a “slow but steady savings pattern is best.”
• You’re already holding cash. Research from Richard Bernstein Advisors suggests that portfolios that held 100% cash through a market trough, and shifted to stocks six months later, outperformed portfolios that invested in stocks for the entire period.
• You’re investing in previous market leaders. When the market struggles, companies experience leadership changes and fund managers adjust their holdings. Don’t assume previous market winners will reclaim their titles.

Rule of Thumb #6: Withdraw No More Than 4% Annually From Your Retirement Portfolio

What to know:

In addition to Bill Bergen’s “4% rule,” consider anticipated changes to your overall spending patterns. Research from former Morningstar researcher David Blanchett found that individuals often experience a decline in discretionary spending throughout the course of retirement as they become less active, though total costs (including healthcare expenses) follow a “retirement spending smile” pattern.

Think about income consistency as well as your desired lifestyle in retirement. Would a fixed or flexible withdrawal strategy better enable you to fulfill your goals?

When to follow it:

• You want to prioritize stable cash flow. The safe starting withdrawal rate fluctuates each year as the market environment changes, but Morningstar research finds that 4.0% or lower is typically a good yardstick for consistent income.
• 20%-40% of your portfolio is in equities. In a down market, Morningstar research shows that even a 2% starting withdrawal—much less 4%—can be dangerous for an all-equities portfolio.
• You want to leave more to your beneficiaries. Reducing the withdrawal rate makes it more likely that you’ll have funds to leave to your heirs.

When to break it:

• You’re willing to employ a flexible withdrawal strategy. For example, not fully adjusting your withdrawal rate for inflation or taking less in down markets. These approaches inherently create cash flow volatility but can also enlarge your starting and lifetime withdrawals.
• Guaranteed income will supply some household spending. If part of your income comes from Social Security, a pension, or an annuity, changes in portfolio spending may be more tolerable.

Rule of Thumb #7: Maximize Matching Contributions to Your Employer’s Retirement Savings Plan

What to know:

Nearly half of all retirement plans with a match have a match ceiling of 6%, according to research from T. Rowe Price.

Free money typically isn’t something to turn down, though there can be exceptions. For instance, maybe you have an immediate need that takes precedence over long-term goals.

When to follow it:

• Pretty much always. Maximizing matching contributions is a good idea for anyone in a stable financial situation. It’s money that you can’t get elsewhere, and it’ll only compound over time.
• Your retirement plan offers auto-enrollment or auto-escalation. If you’re automatically enrolled, you’re ahead of the game on making saving a habit. Some retirement plans also offer auto-escalation, where the percentage you contribute ticks up slightly over time.
• You need to catch up on retirement savings. If you got a late start to retirement savings, additional funds provided by your employer are particularly beneficial.

When to break it:

• You have high-interest debt. These expenses are top priority. High-interest credit cards or student loans can set you back more than matching contributions to a retirement plan will set you ahead.
• You don’t have adequate emergency funds. Having three to six months of savings is another core priority to put above retirement savings. Once the essentials are covered, you can reprioritize retirement planning.

Rule of Thumb #8: Prioritize Hedges Against Inflation

What to know:

Though workers’ salaries don’t always keep pace with inflation, they typically see enough adjustments to help maintain your purchasing power. You may need to be more concerned about preserving purchasing power in retirement, when assets are more fixed.

Based on your desired timeline for starting portfolio withdrawals, you can identify how much of a priority inflation hedging should be.

When to follow it:

• You have a lot of bonds. Inflation is a greater threat to a bond-heavy portfolio than a stock-heavy one. Bond investors may choose to prioritize inflation protection with Treasury Inflation-Protected Securities.
• You need funds in the short term. Though an all-cash portfolio isn’t a winning long-term strategy, it is a good way to ensure you have some funds accessible during an inflationary environment.

When to break it:

• You have an equity-heavy portfolio and a longer time horizon. Stocks tend to be a fairly resilient long-term inflation hedge, because companies tend to have a certain amount of pricing power. They may be able to pass their increased expenses along to their consumers or may not be particularly dependent on the cost of raw materials to maintain their profit margins.
• You’re considering niche asset classes. Returns on supposed inflation-hedging asset classes like gold or cryptocurrency are unpredictable. Don’t start investing in niche asset classes purely in the interest of inflation protection.
• The focus on inflation is causing you to ignore other portfolio risks. Inflation-hedging efforts shouldn’t come at the expense of managing other risks like recessions or geopolitical tensions.

Rule of Thumb #9: Hold 100 Minus Your Age in Stocks

What to know:

This rule of thumb states that 100 minus your age equals the percentage of your portfolio that should be in stocks. So, if you’re 60: 100 – 60 = 40% in stocks.

Remember this guideline is intended for your retirement portfolio, not shorter-term goals.

Consider the timeline of your long-term goals. Do you want to prioritize having funds to spend during retirement or ensuring your beneficiaries feel financially secure? And what do these goals mean for your timeline and asset allocation?

When to follow it:

• You want to keep investments simple. This rule has stuck around so long because it’s so intuitive. If you’re tempted to engage in market-timing or, alternatively, are worried that you don’t know what you’re doing, this is a good starting point for your retirement portfolio.
• You could use a nudge to rebalance. Many investors don’t rebalance regularly, so having a designated goal of keeping your allocation in line with an age-based target can be a good reminder.

When to break it:

• You’re decades from retirement. An investor who has 40 years left in the workforce doesn’t necessarily need much fixed-income exposure in their retirement portfolio and is typically fine to step up their equity exposure.
• You want to leave money to your beneficiaries. If you’re looking to set aside money for heirs, you can keep a greater portion of your money in equities longer.
• You have a longer life expectancy. Today, following the 100-minus-age rule could make it hard to keep up with inflation throughout your life.

Rule of Thumb #10: Retirement Is the End of Work

What to know:

This might seem obvious—of course retirement is the end of work.

But what do you consider “work”? Retirement shouldn’t be considered an on/off switch between being productive and not. It can just as easily give way to caregiving work or an encore career.

Think about whether your goals might align with reframing retirement from “the end of work” to “a different kind of work.”

When to follow it:

• You need a break. You’ve been in the workforce for 30 or 40 years, and maybe you’re not ready to think about more work. It’s OK to take a break and not worry about your next project yet.
• You’re struggling to switch from a saving to a spending mindset. Many retirees struggle with giving themselves permission to start spending money that they’ve spent decades accumulating. But recognizing the end of work might help you accept why you’re starting to use those funds.

When to break it:

• Structure will give you a sense of purpose. Retirement might be a good chance to turn your hobbies into work, which can provide purpose but still feel like you’re doing something different from “work.”
• You want to keep working. Retirement at age 65 isn’t the final test of whether you invested well enough during your life—your choice to continue working can be driven by a multitude of factors, including your own lifestyle preferences.

Morningstar researchers Amy Arnott, Christine Benz, Danielle Labotka, and Samantha Lamas provided the research featured in this article.