January 2005  Email this  Print this
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FINANCE
Rating the Rules of Thumb
by Kimberly Lankford
These 12 guidelines are often touted as financial words to live by. Should you accept them as gospel truth? Close credit accounts you no longer use.
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Cut up the cards, but don't close the accounts because you could end up hurting your credit score. Assuming your history with those accounts is good, you'll want to keep them on your record.
Closing old accounts also lowers the amount of credit you have available, and that can actually be a black mark on your record. When lenders decide whether to extend credit, they look at how much of your available credit you're 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 $6,000. That gives you a utilization ratio of 12% -- not bad, in the eyes of lenders. But if you close four of those accounts, your ratio suddenly jumps to 60% -- not good.
"You haven't borrowed an additional nickel, but on paper it looks as if you're closer to being overextended," says Craig Watts of Fair Isaac, the company that calculates the credit scores most lenders use. Ideally, you should keep your utilization ratio below 50%, says Maxine Sweet of the credit bureau Experian.
Set up an emergency fund to cover three to six months' worth of your expenses.
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You can get by with a smaller stash -- say, enough to pay two or three months' worth of expenses -- as long as you have a low-interest home-equity line of credit.
When calculating your expenses, don't forget to include the deductible on your auto- or homeowners-insurance policy, whichever amount is higher.
The idea is to keep enough cash on hand so that you don't have to sell stocks or rack up expensive 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 needs to be safe and accessible, which means keeping it in a bank money-market account or a money-market fund with check-writing privileges (you can find the best rates at www.bankrate.com or www.imoneynet.com).
The percentage of stock in your portfolio should equal 100 minus your age.
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It's not a bad guideline, it's just too conservative. Think of it as a baseline figure rather than a hard-and-fast rule.
Consider a couple who retire at age 65. With only 35% of their portfolio in stocks, says Evelyn D'Amico, a financial planner in Paoli, Pa., "their assets will have a tough time growing enough to keep up with inflation." D'Amico recommends that her clients have at least 50% of their retirement assets in stocks at age 65.
For a more aggressive guideline, modify the rule to subtract your age from 110, and then multiply that figure by 1.25, recommends Stuart Ritter, a financial planner with T. Rowe Price. Using that formula, our 65-year-old couple would keep 56% of their portfolio in stocks. For a 50-year-old, the stock portion would be 75%. If you can count on a traditional pension to provide a guaranteed annual income, you can afford to be even more aggressive.
Bear in mind that this rule applies to the long-term portion of your portfolio. Money you're saving for shorter-term goals that are fewer than five years away should be invested more conservatively.
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