I recently taught
a new class about common financial planning guidelines that include numbers. I
started the class by noting that a guideline is a recommended principle, course
of action, or piece of advice. Unlike rules and laws, which are mandatory,
guidelines are not action steps. Instead, people follow them voluntarily to
guide their daily actions and decisions.
Interestingly, however,
many personal finance guidelines do use the word “rule.” Examples include the
4% Rule and the Rule of 72. Once again, they are not rules, as in required
actions, but, rather, suggested calculations. Some financial guidelines involve
ratios which are derived from combinations of numbers.
Below are seven
examples of ten financial guidelines with numbers:
20/4/10
Rule- This is a guideline for car loans. It suggests making
a 20% down payment (e.g., $10,000 for a $50,000 new car), financing the car loan
for no more than four years, and keeping monthly expenses under 10% of gross
income (e.g., $5,000 with a $50,000 income).
50/30/20
Rule- This is used as a guideline for household budgeting.
It suggests spending 50% of household income on needs, 30% for wants, and 20%
for savings and debt repayments. For example, with a $50,000 annual income,
$25,000, $15,000, and $10,000, respectively.
Consumer
Debt-to-Income (DTI) Ratio- Suggests that all monthly debt
payments (excluding a mortgage) should not exceed 15% of net (take-home) pay
and a 20% DTI ratio is considered a “danger zone.” For example, the ratio for monthly debt of
$600 and $4,500 net income is 13.3%.
Rule
of 25- A common retirement savings target is 25 times your
desired retirement spending (not covered by guaranteed income like Social
Security and a pension) by the time that you retire. Example: if you need
$60,000 per year, 25 x $60,000 = $1,500,000
Rule
of 72- This is a shortcut to estimate how long it takes to
double a sum of money at a certain interest rate, Simply divide the interest
rate into 72. For example, with 6% interest, it takes 12 years (72 ÷ 6) to
double your money.
Three
Fund Rule- This is a simple guideline to build a low-cost,
globally diversified, investment portfolio with just three mutual funds: a U.S.
total stock market index fund, an international stock index fund, and a U.S.
total bond index fund.
Three
to Six Rule- Setting aside enough savings to cover
three to six months of essential living expenses (e.g., housing, food,
utilities, insurance, transportation, and debt repayments). If this is not
possible, save what you can. Any emergency fund savings is better than none!
This post provides
general personal finance or consumer decision-making information and does not
address all the variables that apply to an individual’s unique situation. It does
not endorse specific products or services and should not be construed as legal
or financial advice. If professional assistance is required, the services of a
competent professional should be sought.
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