Rules of thumb, also known as general guidelines, can be a useful tool in managing your finances. They can serve as a starting point for budgeting, saving, retirement planning, and other financial decisions. However, it’s important to remember that each individual’s financial situation is unique. That’s why it’s crucial to adapt these guidelines to fit your circumstances.
Here are 5 popular rules of thumb you can follow to help with your finance.
50/30/20 rule
The 50/30/20 is a popular budgeting guideline that suggests allocating 50% of your after-tax income toward Needs, 30% towards Wants, and a minimum of 20% for savings and investments. “Needs” are items that are necessary for day-to-day survival, like housing, utilities, groceries, and insurance. The “Wants” category comprises discretionary items such as dining out, travel, clothing, and entertainment. The “savings” category includes savings for emergency funds, investing for retirement, and paying off debt (except mortgage).
The rule provides a very good starting point for someone just starting on their budgeting journey. As you become more familiar with your spending patterns you can decide how much to allocate to each category
20/4/10 rule
A car is often the second biggest expense for a household and the 20/4/10 rule helps to narrow down the price of a car to look for when shopping for a new car. The rule suggests putting at least a 20% down payment for the car and finance for no more than 4 years and the monthly expense for the car, including car payment, insurance, gas, and maintenance should be a maximum of 10% of gross income.
The idea behind the 20% down payment is to lower the overall cost of the car by reducing the amount financed. The 4-year financing rule is to avoid long-term car loans that can become a financial burden and 10% of gross income rule is to ensure that the car payment and other car-related expenses do not consume a significant portion of the individual’s income.
25% of income on housing
This guideline suggests keeping your housing costs (mortgage/rent) to a maximum of 25% of your after-tax income. Housing is the biggest expense for most people and trying to adhere to this rule would allow them to have some money left over for other expenses and not feel financially squeezed. However it may not always be possible to keep housing costs strictly within 25% of income, especially in expensive real-estate markets, like Toronto and Vancouver, the idea is to keep the housing costs as close as possible to 25% to help ensure a balanced budget.
Rule of 72
The rule of 72 helps to estimate the number of years it would take for an initial investment amount to double for a given rate of return. You can divide 72 by the interest rate to estimate the number of years it will take for an investment to double. For example, if the rate of return of an investment is 8% then it would take approximately 9 years (72/8) for an investment to double in value. The rule of 72 is helpful to calculate a rough estimate of the number of doubles an investment can provide over a given period. An investment returning 8% over 30 years would provide approximately 4 doubles or 16 times the initial investment over those 30 years.
Saving 25x expense for retirement
This guideline suggests having 25x an individual’s yearly expense in investments for them to be able to retire and live comfortably for the rest of their life. For example, an individual having a $40,000 yearly expense would need $1,000,000 to be able to retire whereas someone with a more expensive lifestyle of $100,000 per year would need $2,500,000 in investments to retire comfortably. The idea is that at such investment amounts, the average return of the portfolio would be able to fund the lifestyle without the need to add additional dollars to the investment.
Be First to Comment