Financial Rules of Thumb You Should Know
We’ve all heard of various “financial rules of thumb” but what actually are they? These methods can offer you guidelines to save and manage your money and expenses. It is wise to realize that while these rules of thumb can be great for a quick check-up on your financial position, they are no substitute for a financial plan tailored to your personal situation. Having this knowledge could help you reach your long-term goals and short-term goals. In this article, we will be going over several financial rules that can help you can start practicing today.
Percentage of Gross Income You Should Save For Retirement
Once you've finished paying off most of your (high-interest) non-mortgage debt and established an emergency fund of at least 3-6 months of expenses, an excellent objective to strive for is 10-20% of your gross income. This percentage includes the amount you save in your 401(k) (including any corporate match) and any other retirement accounts. If you're just beginning to save for retirement, 10-20% may seem like a stretch. That’s ok, you can start small and build up gradually over time. A good goal may be to start contributing up to the employer match and then raise the contribution level each year. Starting small gets you into the system and in the habit of putting money aside for retirement.
Emergency Fund Saving
A typical target amount is 3-6 months of expenses, although your unique situation may necessitate a higher or lower amount. Consider the following factors:
What industry do you work in, and how long does it generally take you to find employment if you lose or quit your job?
What stage of your career are you in, and what amount of income are you looking to replace? (Higher-level salaries may be more difficult or time-consuming to replace than lower-level compensation.)
Are you the only individual in your family who works?
If your income was interrupted due to illness, do you have adequate health and disability insurance? How long could you manage to pay your bills if you couldn't work?
In a realistic world, you would finish paying off all of your credit card debt before fully funding your emergency fund. Even if you have (hopefully little) credit-card debt, you should consider saving some money in an emergency fund for the minimal necessities.
What Should I Spend When Buying a House or Renting?
With the 28/36 rule, a mortgage lender will most likely propose to you a mortgage if your total monthly PITI (Principal, Interest, Taxes, and Insurance, plus any homeowner association fees in a home) is below or equal to 28% of your month to month gross income, and your total monthly PITI plus all your other monthly debt payments are below or equal to 36% of your month to month gross income. Don't think that just because a mortgage lender is ready to lend you a specific amount that, this is the right amount for you. Determine how your PITI payments will fit into your entire budget in your new house, including all other expenses involved with homeownership. Don't become a "house poor" individual. Use the 28/36 Rule as a guideline, but create a budget that truly works for you. Remember to include other costs like remodeling, moving charges, closing costs, new decor, etc.
Allocating Your Monthly Income
Think of the 50/30/20 rule:
50% of your monthly income after taxes should be used for your needs like groceries, vehicle maintenance, clothing, housing, car or medical insurance, etc.
30% of your monthly income after taxes should be used for your wants like memberships, traveling, eating out, etc. Basically, stuff that you do not require to live off of or need.
20% of your monthly income after taxes should be used for your savings, paying off debt, and investing.
Of course, the 50/30/20 Rule is only a recommendation. One advantage of reviewing your budget utilizing a 50/30/20 distribution is that you can compare your expenses to a benchmark, allowing you to discover target areas for spending reductions. A real 50/30/20 split may be difficult to attain, particularly if you are just beginning, reside in a city with high housing prices, have a substantial student loan burden, or raise a family on one salary. However, this just indicates that this is something to strive for.
Yearly Retirement Withdrawals
The 4% Rule is a guideline that retirees may use to determine how much they should take from their retirement accounts each year. Implementing the rule is to maintain consistent revenue while keeping an acceptable total account balance for future years. The withdrawals will mostly comprise interest and dividends on savings. This rule helps you make your retirement savings last up to 30 years or more. It allows you to predict and maintain a consistent income which protects you from running out of money.
There are various instances in which the 4% rule may not be appropriate for a retiree. A severe or prolonged market downturn may devalue a high-risk investment vehicle faster than a more balanced retirement portfolio. Also, if today’s low interest rate environment persists, this could impact the long term validity of this rule of thumb.
Furthermore, the 4% Rule does not work unless a retiree adheres to it year after year. Violating the rule of one year to indulge in a significant purchase can have serious long-term ramifications since it diminishes the principal, which directly influences the compound interest on which the retiree relies for sustainability.
Doubling Your Investment
The Rule of 72 is an easy formula for calculating how long it will take for an investment to double, given a fixed annual interest rate. You can figure this out by dividing 72 by the yearly rate of return to get a general estimate of how long it will take for the initial investment to double. For instance, if you divide 72 by an annual fixed interest rate of 9% (72/9=8) it would be about eight years for the investment to double. When it comes to the efficiency of this rule, the best results are obtained at an annual interest rate of 8%. Nevertheless, you may use it with confidence for any percentage ranging from 4% to 15%. Beyond these limits, the rule becomes inaccurate to be relied on. But, in the end, nothing beats a proper compound interest calculation.
Schedule A Consultation with an Experienced Financial Advisor
We hope that you found the information in this article helpful and informative. However, it’s important to remember that these rules of thumb don’t work for every situation. So, if you feel like you need more guidance, we’re here to help. Here at Fourth Avenue Financial, our first priority is your overall financial success. We want to help you develop, implement, and monitor a strategy designed to address your individual situation to ensure all your investments are setting you up for a path of financial success. If you are ready to start planning for your financial future, we are here to help. Contact us today at (304) 746 7977 to schedule a meeting with one of our experienced financial advisors or schedule online: https://calendly.com/fourthavenuefinancial/introductory-zoom.
Securities are offered through J.W. Cole Financial, Inc. (JWC) Member FINRA / SIPC. Advisory Services are offered through J.W. Cole Advisors, Inc. (JWCA). Fourth Avenue Financial and JWC/ JWCA are unaffiliated entities.