While everyone faces a different financial situation, like many areas of life there are helpful rules of thumb when it comes to the best financial planning tips. These useful guidelines can act as a good starting point for anyone who wants to get their finances in order, start saving for retirement, buy a home, or determine if a purchase or investment is truly worth it.
Though some of these rules of thumb for personal finance may have to be tweaked depending on your specific financial situation, tailoring them to your needs is a great way to begin moving forward and can help you achieve your goals. Here are 4 financial rules of thumb to consider:
- Determining Your Spending Potential – When it comes to creating a budget or allocating funds for an investment or purchase down the road, you are basically playing a saving vs. spending game. While you may hear of people creating intricate budgets, the reality is very few actually follow these budgets verbatim. If budgets like this bog you down or you feel it isn’t something you would typically follow long term, consider at least adhering to the simple rule of thumb of 50/15/5.
With this guideline, 50% of your take home earnings are used to pay necessities – this includes food, debt, medical care, shelter, and transportation. Then, the next 15% is used as a contribution for your retirement savings account. The following 5 % should be stored in a savings account that is only used for unexpected expenses, such as your washing machine breaking, a leaky faucet, or fixing your car.
At this point, you have a guideline for the first 70% of your take home income. Consider the remaining 30% available for fun activities, goals, such as taking up a new class or hobby, etc.
- Renting vs. Purchasing – Another important financial rule of thumb involves the decision of purchasing or renting a home. Knowing how to use a price-to-rent ratio will come in handy when you are torn between this decision.
To properly decide which is better, find two housing spots that are similar in location, size, etc. Divide the sale/purchase price of house number 1 by the annual rental price of house number 2. Your answer is your P/R ratio. For example, let’s say you find a $300,000 home for sale, but a very similar home on the next street for rent for $1,500 per month. Diving 300,000 by 18,000 (1,500 X 12), and you will get a P/R/ ratio of 16.7.
If your P/R ratio is above 15, it is likely better to rent; lower than 15, and you would be better off buying.
- Saving for Retirement – There is no one size fits all equation for retirement, and there are different personal finance rules depending on your lifestyle, income, and medical needs. To help get you to where you need to be however, there are different financial rules of thumb to help you along the way. One rule of thumb is to have at least saved 10 times your annual salary by the time you retire (assuming this is at age 67). Other financial rules of thumb for retirement include savings at least 15% of your pretax earnings up to age 67. Also, don’t forget to take advantage of employer’s profit sharing or 401(k) employer match, if applicable.
- Conquer Your Emergency Fund – We hear a lot about emergency funds, and with good reasons. These funds help keep you afloat when the unexpected occurs. Depending on who you speak to, you may hear that savings any where between $1,000 up to a year’s worth of your expenses is a good frame of reference. Another rule of thumb for this financial area is to use the following equation: Emergency Fund = X months of expenses, where X is the current unemployment rate. Currently, the Bureau of Labor Statistics estimates unemployment at 4.1%, so according to this equation, you would aim to have 4.1 months of expenses in your emergency fund.
Using the above rules of thumb for personal finance can be a great way to start on the road to financial freedom. As milestones are achieved, you may want to dig deeper into investing, saving, and setting up retirement strategies. Consider working with skilled financial planner Matt Logan to take your financial savvy to the next level.
Matt Logan Inc. is an independent firm with Securities offered through Summit Brokerage Services, Inc., Member FINRA, SIPC. Advisory services offered through Summit Financial Group Inc., a Registered Investment Advisor. Summit Brokerage Services, Inc., its affiliates and Matt Logan Inc. do not give tax or legal advice. You should consult an experienced professional regarding the tax consequences of a specific transaction. These are the views of Matt Logan Inc., and not necessarily those of Summit Brokerage Services, Inc. and any of its affiliates and should not be construed as investment advice.