What’s the first rule in personal finance? My suggestion: Always look for ways to stay in the center lane—that is, to take a balanced approach. As the new year gets started, here are 10 ways you could apply this principle.
Housekeeping. Over time, many of us accumulate a mixed bag of investment holdings—some good, some not-so-good. Those in the not-so-good category can pose a challenge. Suppose you own an expensive mutual fund, for example. If it’s in a retirement account, you could exit the fund without worrying about any tax impact. But what if a sale would entail a taxable gain? Then it’s harder to know when a sale might be worth it—because there’s no way to know how the investment you sell will perform after you sell it and no way to know how the new investment will perform after you buy it. All too often, I’ve seen folks hold onto substandard investments to avoid a 15% or 20% tax bill, only to see that investment underperform by more than 15% or 20%. But because there’s no way to know how things will turn out, this is precisely the sort of situation where you might opt for the center lane. How? Don’t view it as an all-or-nothing decision. Instead, you might chip away at an investment a little bit each year, with a goal of eliminating it over three or five years.
Index funds. Among the reasons why I see index funds as the best choice for most investors most of the time: They can help your portfolio’s performance stay in the center lane. Of course, there’s a price to pay for owning index funds, which is that you’ll never score the sort of homerun you might with a winning stock. But in exchange for that, you’ll also never find yourself suffering the sort of underperformance that an investment misstep can inflict.
Retirement contributions. Suppose you’re starting a new job and are offered a choice between a tax-deferred 401(k) or a Roth. In some cases—if you’re in a very high or very low tax bracket—this is an easy choice. But what if you’re in one of the middle brackets—either 22% or 24%? The math in these cases is often inconclusive. That would be a good opportunity to choose the center lane and split the difference on your contributions.
Life insurance. Folks later in their careers often wonder when it would be prudent to cancel a term life policy. In many cases, the math indicates that it would be safe to cancel only some amount of coverage. If you have more than one policy, this is possible, by canceling one and holding onto the other. But if you have just one large policy, you may be stuck with an all-or-nothing decision. That’s why, if you’re early in your career and in the market for life insurance, you might consider splitting your coverage between two or even three policies to buy yourself that flexibility.
Social Security. Because Social Security can be claimed at any point between ages 62 and 70, it’s the subject of endless debate. The conventional wisdom is to wait until 70, for the largest possible benefit. I agree with that. But if you’re married, it often makes sense for one spouse to claim at least a little earlier. While this strategy may not appear mathematically optimal, the reality is that none of us knows how long we’ll live, so any amount of math is still just a guess. My recommendation: Steer clear of the age-70 dogma and instead take a center lane approach.
Annuities. The reality is that Social Security is one of the best annuities available. But if you’re looking for additional retirement security, a single-premium immediate annuity (SPIA) might not be a bad choice. In general, annuities have a bad reputation because they tend to be loaded with opaque fees. But SPIAs tend to be the best of the bunch, and if a permanent paycheck is what’s most important, I wouldn’t get bogged down in the negativity surrounding annuities. Instead, you could split the difference by annuitizing just some of your assets.
Pensions. If you’re lucky enough to have a traditional defined-benefit pension, your employer will typically give you a choice when you reach retirement age. You can accept the benefit as a lump sum, which you can then invest on your own. Or you can opt for guaranteed monthly payments for life. Often, the math in these cases will point in the direction of the lump sum. But before you make that choice, remember Irene Triplett. When she died in 2020, at age 90, she was still receiving a pension benefit based on her father’s military service—in the Civil War.
Debt. Suppose you’ve just received a year-end bonus. Should you allocate some of it to paying down debt? This is another question that lends itself to an easy calculation on paper. If the interest rate on your loan is lower than what you might earn investing those dollars, then it makes sense not to pay down that debt and instead to keep those dollars invested. But when it comes to debt, there’s more to the equation. For many people, reducing debt provides a peace-of-mind benefit which can’t be quantified. And by reducing your monthly cash needs, a lower debt load buys you flexibility—to switch into a different role with lower pay, for example, or even to retire early. The upshot: You might consider reducing a loan balance even when the math says you shouldn’t.
529s. When they were first instituted, 529 accounts were limited to higher education-related expenses. But that changed in 2018, and now 529 funds can also be used for K-12 expenses—up to a cap of $10,000 per year, per student. While this new flexibility is welcome, it also makes the math harder. Not only do parents need to estimate the future cost of college, but they now also need to predict whether their children will go to a private elementary or high school. That’s one reason I recommend making incremental contributions to 529 accounts over time. In theory, you might benefit by making a larger contribution earlier. But because the total tuition obligation is so hard to estimate, you might be better off with a center lane approach.
Gifting. If you have adult children, should you help them financially, and if so, to what degree? Warren Buffett suggests this rule: Give children enough that they can afford to do anything, but not so much that they can afford to do nothing. While few are at the level of Warren Buffett, I see this as a useful guideline because ultimately we want children to be motivated to earn their own success. At the same time, though, life is expensive, so most parents want to help to the extent they can. What’s the solution? I recommend making gifts incrementally, perhaps annually. That will give both donor and recipient an opportunity to test the waters. You can then adjust future gifts accordingly.
In his 2023 book, Decisions about Decisions, Cass Sunstein offers this useful guideline on making decisions: Try to determine what the frequency, likelihood and magnitude would be of a potential error. That can help you decide how close to the center lane you want to be.
