The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #18: The best way to improve your credit score is to pay bills on time and to borrow no more than 30% of your available credit.

In the United States, the most common type of credit score is the FICO score (or Fair Isaac Corporation score). From the Wikipedia credit score entry:

Although the exact formulae for calculating credit scores are closely guarded secrets, Fair Isaac has disclosed the following components and the approximate weighted contribution of each:

* 35% punctuality of payment in the past (only includes payments later than 30 days past due)
* 30% the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
* 15% length of credit history
* 10% types of credit used (installment, revolving, consumer finance)
* 10% recent search for credit and/or amount of credit obtained recently

Money’s rule seems to directly address the first two: pay your bills on time to reduce late payments, and reduce your credit card debt to improve your debt ratio. But where does that 30% number come from?

The fact of the matter is that there is no specific number that qualifies as a “good” ratio, just that lower is always better. Different reporting agencies use different formulas to calculate a “good” and a “bad” debt ratio and don’t disclose the actual contents of the formula, leaving you to guess what is best.

In short, you shouldn’t necessarily feel good if your credit ratio is below 30%. You should feel good if your credit ratio is lower now than it was six months ago, as every time you decrease your ratio, you help your credit score.

Another tip is that by canceling credit cards, you’re actually hurting yourself in two ways. First, you’re reducing the total available revolving credit that you have without reducing the amount of current debt you have, thus raising your credit ratio. Second, by eliminating lines of credit, you’re shortening your credit history. Simply put, if you’ve already got a credit card and paid it off, don’t cancel it; put it away somewhere safe.

Let’s rewrite that rule.

Rewritten Rule #18: The best ways to improve your credit score is to pay bills on time, to reduce the balance on your credit cards, and to not cancel old cards when you’ve paid off their balance.

You can jump ahead to rule #19 or jump back to rule #17.

The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #17: The best credit card is a no-fee rewards card that you pay in full every month. But if you carry a balance, high interest rates will wipe out the benefits.

This rule is absolutely correct in that you should be using a rewards card with no fees and you should be paying off the balance every month. There’s pretty much no other way to use credit cards without a significant loss.

However, this rule is not quite specific enough. It ignores the fact that many rewards cards are just not all that rewarding. The offers sound pleasant, but often you earn 1% or less return on the rewards and many rewards programs are nearly useless for the vast majority of users.

The fact of the matter is you should expect at least a 1.5% reward in a form that you will actually use. If you’re getting below that, I can virtually guarantee that there are better rewards programs out there for you.

I usually use the CitiBank Driver’s Edge Platinum Select card as a baseline for my rewards card comparisons. You earn a 6% rebate on supermarket, drugstore, and gas station purchases in the first year (3% after that), and 1% on all other purchases, plus a $1 rebate on every 100 miles you drive (which you prove using maintenance receipts). These rebates aren’t directly in the form of cash, but are used when you do maintenance, service, or repair on the vehicle assigned to the card. You can also get the rebate if you buy a new car in the next five years. In short, if you perform regular maintenance on your car or acquire a new one, this card will pay for a solid portion of it.

If a credit card offer can’t exceed this one (and not many can), you shouldn’t be using that reward program. Let’s rewrite that rule.

Rewritten Rule #17: The best credit card is a no-fee rewards card that can earn you at least 1.5% in return that you pay in full every month. But if you carry a balance, high interest rates will wipe out the benefits.

You can jump ahead to rule #18 or jump back to rule #16.

The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #16: When you buy insurance, choose the highest deductible you can afford. It’s the easiest way to lower your premium.

I flatly agree with this rule.

…

Of course, when I look at it again, I realize that it’s not including the other big factor in ensuring a low premium: taking advantage of the competition. Insurance carriers are always competing for customers, so there’s nothing but upside for consumers to take some time to review the offerings from other insurance companies.

This is especially true in the internet era, where you can quickly obtain rate quotes from many different insurers with only a mouse click. While the savings that you can obtain from a higher deductible is usually sizeable, combining it with the insurance provider with the lowest rates will usually move money out of the coffers of the insurance giants and straight into your pocket. Let’s rewrite this rule.

Rewritten Rule #16: When you buy insurance, compare the packages at multiple insurance providers with the highest deductible you can afford. It’s the easiest way to lower your premium.

You can jump ahead to rule #17 or jump back to rule #15.

The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #15: You need enough life insurance to replace at least five years of your salary–as much as 10 years if you have several young children or significant debts.

I agree with the spirit of this rule: most people don’t leave behind nearly enough life insurance to ensure the continued success of their family after a tragedy. To me, not having adequate life insurance is a classless act – you’re making a potential tragedy worse by being greedy now.

I also agree with the sentiment about leaving behind more life insurance if you have children, but this is where the rule gets quite vague. What does “if you have several young children” actually mean? It’s a very vague statement that makes me sit back, stroke my chin, and whip out my trusty pencil.

First of all, life insurance should cover your funeral and estate management right off the top. To ensure that everything is taken care of, you should have a minimum of a year’s salary put away. Even if you live entirely alone, this should exist to eliminate any burden you might put on other family members in the event of your passing.

Life insurance becomes important as soon as you begin to build your own family. If your income is even slightly responsible for the well being of anyone else, you need to put away two more year’s worth of salary in insurance to cover the hardships that would overcome them simply recovering from your loss. Beyond that, you want each person dependent on you to be able to continue to live something approximating the life they’re accustomed to, so you should have two years’ worth of insurance for each other dependent as well.

These suggestions add up to a very nifty formula for figuring how much life insurance you should have. Take the number of dependents in your household, double it, and add one. Multiply that number by your annual salary and that’s the approximate number you should be looking at. Let’s rewrite this rule.

Rewritten Rule #15: You should leave behind a year’s worth of life insurance to cover your funeral, plus two years’ salary for each dependent you claimed on your last tax return (including yourself).

You can jump ahead to rule #16 or jump back to rule #14.

The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #14: Aim to accumulate enough money to pay for a third of your kids’ college costs. You can borrow the rest or cover it from your income.

This rule is utter rubbish. Let’s say that you have a newborn child today. How can one reasonably estimate what the cost of higher education will be in eighteen years? The simple fact of the matter is that you can’t, and thus this rule is nonsensical. We know that the cost of education will grow over the next eighteen years. We just have no idea how much.

There’s also a massive difference between the cost of your local state school and the cost of a top-notch private institution. Which do you think your child will be attending? For my parents, they didn’t believe I would attend college at all. For me, I want my child to attend the best school that he can get into, so I’m saving assuming that he’s going to MIT.

So, I check MIT’s financial aid site and it reports that the cost of undergraduate tuition per year right now is $33,600. So, in order to pay for four years of tuition at today’s cost, I’d have to cough up $134,400.

On the other hand, what if I were to send him to the local state school? The cost is about $6,000 a year for in-state tuition. So, to pay for four years there, I’ll have to save $24,000. Right now, I’m saving with a target amount between these two boundaries.

What about room and board, living expenses, and the tuition rise between then and now? I’ll deal with those when the time comes, but for right now, I have a tangible and sensible target to work towards, rather than an arbitrary number. So, let’s rewrite that rule.

Rewritten Rule #14: Aim to accumulate enough money to pay for what four years of undergraduate tuition would cost for your child at the institute of your choice on the day he or she was born. The rest can be borrowed or covered when the time comes.

You can jump ahead to rule #15 or jump back to rule #13.

The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #13: Keep three months’ worth of living expenses in a bank savings account or a money-market fund for emergencies. If you have kids or rely on one income, make it six months’.

This is an appropriate rule #13, as it covers a scary situation that most of us don’t want to think about: emergencies. What will happen if you lose your job? What will happen if the transmission dies in your car? What will happen if you get spinal meningitis? These seem like unlikely things, but eventually something disastrous will happen and you need to be prepared.

This rule is a solid one, but it doesn’t cover every situation. For example, larger households should have more than six months of living expenses in the bank, while single people can get by with as little as two months. Why is this? A household includes people that are entrusted with the responsibility of keeping a child (or children) safe and secure, and the more people in the household there are, the greater the likelihood that an unexpected event could happen.

In short, if you have a large family, you want to be sure that even if two or three bad things happen at once with different family members, you’re fine. That’s why it makes sense to have a certain amount in an emergency fund for each family member, so that your emergencies won’t affed them and vice-versa.

How much is appropriate for each person? Three months is nice, but it is not quite necessary to have a year’s worth of living expenses sitting around for a couple with two kids, plus three is a little bit high for a single person, anyway (unless they like the security blanket). Two months of living expenses per household member is a much better balance of security and reality. So, let’s rewrite that rule.

Rewritten Rule #13: Keep two months’ worth of living expenses in a bank savings account or a money market account for each person in your household. So, if four people live in your household, have eight months’ worth of living expenses.

You can jump ahead to rule #14 or jump back to rule #12.

The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #12: If you’re not saving 10% of your salary, you aren’t saving enough.

This rule has more class bias in it than almost any other rule on this list. It completely ignores the realities of the working class and of the lower middle class and lets the upper middle class, who really should be saving more than 10% of their salary, off the hook.

For example, a single mother who brings home $20,000 a year is supposed to be saving $2,000 of that? The simple fact of the matter is that she can’t and it’s dangerous for the living situation of her and her child if she tries. There is no money to shave off in that situation; the mother’s focus should be in ensuring healthy food and good education for that child so that child isn’t stuck in the same situation. If that mother can sock away a few dollars, that’s great, but saying that anything less than $2,000 isn’t enough is ignoring the economic reality.

On the other hand, let’s look at a married couple bringing in $240,000 per year. Should they only be saving $24,000 a year? They should be saving a lot more than that – if not, they’re spending at a frightening rate and will be working until very late in their lives. Their savings and investments should be exceeding $40,000 a year, easily.

How can both realities be reconciled into a single rule? It’s quite easy, actually; there should be a minimum threshold for living, then above that you should be socking away about 20% of what you bring in for a rainy day. In today’s world, that bare minimum is probably in the $20,000 a year range, but it might be a bit higher than that and will be higher very soon.

Let’s look at an intermediate situation. If a couple brings in $100,000 a year, the Money Magazine rule states they should be saving about $10,000 a year. At that rate, to continue their $100,000-level existence at retirement, they’ll have to work until they are in their seventies. Under the revised rule, the couple would have to save 20% of $80,000, or $16,000 a year. This is a much more healthy target that enables them to retire much earlier and there’s only a $6,000 a year difference, an amount that can easily replace a vehicle payment or a latte each day.

So, let’s rewrite that rule – for now:

Rewritten Rule #12: If you’re not saving 20% of all of your income in excess of $20,000, you aren’t saving enough.

You can jump ahead to rule #13 or jump back to rule #11.

The Simple Dollar is running a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

Rule #11: If you don’t understand how an investment works, don’t buy it.

The sheer hubris of the above statement is incredible. “Leave the real money makers to the experts; you go along and play with your savings account at your local bank, junior.” It’s typical of the attitude of many people in the financial sector as they try to play Prometheus, bringing the fire of financial knowledge from the gods of Wall Street.

The fact is that most investments are not all that complicated. If you are interested in a particular investment, pick up a book at your local library (or your local bookstore) and read about it. This is an opportunity to learn something that could be directly useful to your pocketbook, not an excuse to run for the hills like a coward.

I agree that you should never buy an investment that you don’t understand, but merely saying, “I don’t understand it, so I’m not going to buy it” is a losing philosophy. You’re much better off saying, “I don’t understand it, so I’m going to learn about it.”

Let’s rewrite that rule:

Rewritten Rule #11: If you don’t understand how an investment works, do some research before you invest; don’t just write it off.

You can jump ahead to rule #12 or jump back to rule #10.