Financial Rules of Thumb

Rules of thumb are designed to provide quick guidelines for your finances. However, you shouldn’t blindly follow them without giving
thought to your personal circumstances. Some of the more common
rules of thumb include:

Save 10% of your gross income. While this will give you a good start, it’s typically the minimum, not the maximum, you should be saving. Analyze how much you’ll need for your financial goals, and then work backwards to calculate how much you should be saving.

Plan on spending 80% of your pre-retirement income during retirement. This may be true if you don’t plan to be very active during retirement, but more and more people expect retirement to include extensive travel and expensive hobbies. On the other hand, if you’ve paid off your mortgage and your children have finished college, you may need less
than this. Review your individual situation to determine how much
you’ll need.

Set the percentage of stocks in your portfolio to 100 minus your age. With increased life expectancies, this can result in a portfolio that is too heavily weighted in income investments. Set your asset allocation based on your risk tolerance and time horizon for investing. Stocks should be considered for long-term financial goals of 10 years or more.

Keep three to six months of income in an emergency fund. While an emergency fund is a good idea, how much you keep in that fund will depend on your circumstances. You may need a larger fund if you are the sole wage earner in the family, work at a seasonal job, own your own business, or rely on commissions or bonuses.

A smaller fund may be required if you have more than one source of
income, can borrow significant sums quickly, or carry insurance to
cover many emergencies.

Pay no more than 20% of your take-home pay toward short-term debt. Once considered a firm rule by lenders, you may now be able to obtain loans even if you exceed this amount. Try to reduce your debt or at least reduce the interest rates on your debt.

Keep your mortgage or rent payment to no more than 30% of your gross income. While you can obtain a mortgage for more than that, staying within this rule will help ensure you have money to devote to other financial goals.

Refinance your mortgage if interest rates decline by 2%. This rule of thumb assumes you’ll pay significant refinancing costs, including points, title insurance, appraisal fees, and other fees. However, many lenders now offer refinancing deals with significantly lower costs.  Thus, you should assess whether it makes sense to refinance when mortgage rates decline by as little as half a percent.

Obtain life insurance equal to six times your annual income. Different individuals require vastly different amounts of insurance, depending on whether one or both spouses work, minor children are part of the family, or insurance is being obtained for other needs, such as to fund a buy-sell agreement or to help pay estate taxes. Thus, you should  determine your precise needs before purchasing insurance.

Most financial rules of thumb should not be followed without first considering your individual circumstances. Please call if you’d like to address your needs in any of these areas.

If you would like more information or to discuss your financial concerns