Your temperament matters when it comes to managing money. For example, a person I know tracks every penny of household spending and carefully examines the books at the end of the month. I’ve tried that approach and it didn’t stick. What I’ve done instead is largely automate my savings and charitable giving and, once that’s done, only loosely monitor my accounts. However, I do track spending in detail over several months when trying to reach a particular goal, such as saving more.
Neither my friend nor I are wrong. Like many personal finance issues, there is no one right answer. The key to choosing the “right” strategy is understanding your disposition and your circumstances.
Take eliminating credit card debt. One common method is based on mathematics. You list your credit card debts, starting with the highest rate and move down to the lowest rate card. You target extra savings at the highest-rate card first and pay the minimum on the rest. When the highest-rate debt is paid off, you repeat the process. You pay the least amount of interest with this technique. Another popular strategy is based on psychology. Again, you list your debts, this time from the smallest balance to the largest. The interest rate is irrelevant. You attack the smallest balance first, paying the minimum on the rest. When you have eliminated that debt, you go on to the next smallest debt. The idea is that quickly paying off one card will help you stick with your debt reduction plan.
Which method you should follow depends on your personality and habits.
The same goes for how best to deal with retirement-savings withdrawals. If you withdraw too much early in retirement, you run the risk of exhausting your savings prematurely. Yet if you are too conservative you might not live as well as you could.
Two of the better-known techniques for handling the dilemma are the 4% rule and the bucket strategy. Briefly, the 4% rule assumes a baseline portfolio of 60% stocks and 40% bonds. You take out 4% of your portfolio each year, with adjustments for inflation. The “bucket” strategy requires setting aside enough cash to cover at least one year or more of necessary expenses. Money that won’t be needed for several years at least is invested in a riskier well-diversified portfolio that may earn higher returns while the cash portion gives you peace of mind.
These techniques are starting points. They are also very different. Which one is best for you — or another of the main withdrawal tactics — largely hangs on your temperament.
Chris Farrell is senior economics contributor, “Marketplace,” and Minnesota Public Radio.