"Rules of thumb. Finance can be hard. Rules of thumb are easy. So, finance rules of thumb are useful. A rapid-fire sampling: Your mortgage, including taxes and insurance, should not exceed 29 percent of your gross monthly income."I'd make that "lodging" and throw in electricity and gas utilities and make that 30%, but that's a quibble.
"All vehicle payments should not exceed 15 percent of your take-home pay. If an auto repair costs less than half of the vehicle's trade-in value, repair it. Otherwise, consider selling it and buying another.Some other sources say 10%. If you can do it, the better rule of thumb is not to finance a depreciating asset at all, but to pay cash and then pay yourself back to finance the next car.
"Spend no more than 1.5 percent of your gross income on the holidays, haincluding gifts and travel.
"Save 10 percent of your take-home pay."By far the easiest way to enforce this discipline is to do this automatically. This can be by payroll deduction like a 401k, or by making payments to a mutual fund group like Vanguard or T. Rowe Price on the same days you get paid. It's easiest if the money doesn't really land in your checking account.
But 10% seems to assume you are saving only for retirement, and that you are starting to save for retirement early. If you are saving for a lot of other things as well (say, putting 3 kids through M.I.T.) this won't be enough. And the later you wait to start saving, the more you will need to save.
"For kids' allowance, give $1 weekly per grade in school. A fourth-grader gets $4.
"For life insurance, buy a policy worth 6 to 10 times your gross annual income."That's a lot of life insurance, and that's a new rule to me. I guess this might make sense if you had small children (I had about 4 times gross income then, mostly in term.) Now that my children are grown I've cut back on this substantially. When you are older the premiums on term get a lot higher, and life insurance for most of us isn't an intelligent way to fund retirement.
"With mutual funds, be wary of funds with an expense ratio of more than 1 percent."Index funds are the best choice for most people, and at a place like Vanguard you can have expense ratios well below this. I wouldn't say "be wary", I'd say "don't even look at funds" with expense ratios this high.
"Don't borrow more money for college than you'll make in your first year working after graduation.
"In a choice between spending on things or experiences with other people, choose the latter. Research shows it makes us happier."Take pictures of those experiences, and keep a journal or blog. It will bring back those memories later.
More rules of thumb:
Here's other rules from various sources.
- After you retire, you will need 70%-80% of your pre-retirement income.
- To find the percentage of your portfolio that should be invested in stocks, take the number 100 and subtract your age.
- save about 20x your gross annual income to retire. In other words, if you earn $50,000 per year, you’ll need $1,000,000 to retire.
- Once you retire, you can withdraw 4% per year.
The 4% rule depends on a lot of assumptions, but nearly everything you are trying to forecast over a decades-long retirement horizon involves a bunch of assumptions. The rule seems decent.
- Don't invest more than 10% of your portfolio in your company's stock.
- The Micawber Principle (from Charles Dickens): Maintain positive cash flow.
- "Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery."
I'm working on a series of posts on rules of thumb for my blog and stumbled across your article. Great list, and I've added a few two my list to write about in the future!ReplyDelete
J.D. Roth's nice list of financial rules of thumb is here: http://www.getrichslowly.org/blog/2009/03/09/25-favorite-financial-rules-of-thumb/ReplyDelete
Roth has a simpler version of the 4% rule:
"In his fantastic book Work Less, Live More, Bob Clyatt shares a common retirement rule of thumb. If you expect to withdraw from your portfolio for 40 years or more, you can probably safely withdraw and spend 4% of its value every year. (Clyatt notes that you can increase this amount to 4.5% with only “slightly diminished safety”.)"
This version is not only simpler, it makes more sense. You don't want to increase each year if your assets have taken a hit due to market fluctuation downward.
If market fluctuation is upward, you don't HAVE to spend 4%.