10 Rules of Thumb for Personal Finance

Hey, what's up everyone and welcome to the School of Personal Finance. Happy Super Bowl Sunday coming up. I'm sporting my OBJ jersey probably for the last time. So, in this video, we are going to go over 10 rules of thumbs when it comes to your personal finances. I'm going to share my thoughts and opinions, things that you probably have heard, some of them you might not have ever heard before, but hopefully you find this one helpful. All right, let's get to it. All right, so real quick, make sure to head over to schoolofpersonalfinance.com and get on my mailing list. Also, check out the Education Center. I'm going to be launching a soft opening with it where I'm going to be charging a one-time fee where you get lifetime access to everything that I'm going to be doing in the Education Center. So, go over schoolofpersonalfinance.com and check it out. Rules of thumb. So, I am a fan of using rules of thumb. As long as you take them with a grain of salt, you take them for what they're worth because all they are is a starting point. You can't really base your decisions around a rule of thumb, but as a starting point, as a general idea to make sure that you're tracking towards the right things or that you're making solid decisions, I like using rules of thumb. So, what I'm going to do in this video is I'm going to go through 10 of them. Most of them are pretty common ones. A lot of them you might hear me talk about, and I'm going to share my thoughts and we'll just kind of go through them all. So, for number one is to always have three to six times your monthly expenses in an emergency fund. Now, I do think that this is a good general rule of thumb, but it totally depends on your situation. So, the three times your monthly expenses, that is typically for married couples that might have stable jobs where maybe both of them are working, and if one loses their job, the other one is still going to have their job, or if they're really stable, that's on the lower end, three months. Six times is people that are maybe self-employed or maybe there's only one spouse in the household that is working where you want to go more towards that six-month time period. If you watch my stuff, then you know that I don't love keeping a lot of cash anywhere with interest rates being so low. Now, I made a video a while back talking about emergency savings and the different levers that you want to have in place that you can pull in case you really do have an emergency so you don't have to tie up so much cash just having it sit earning, you know, 0.01% in a savings account. So, I'll put a link to that video down below. But overall, if you have three to six times of your monthly expenses in a savings account, that helps you sleep better at night. It gives you peace of mind. You'll find yourself less stressed and a little bit happier if you have that amount of money saved in the bank. So, to have that as a rule of thumb, I'm a fan of that. Now, number two is the 50-30-20 rule. So now, this is around savings and budgeting. So, like 50% of your income should go to your necessary expenses. So, like housing, health insurance, food, groceries, things like that. And then 30% should go more towards wants that you may have, things that you want to spend money on that might not be considered a necessity. And then 20% of your income should go towards your savings and investments. And you can even break that 20% down a little bit more into like 15% into retirement savings and then 5% into shorter term savings. So, I do like this as an overall rule of thumb. But what I like to focus on here is the investment piece, the amount that I'm saving each month out of my total income. And we call that the savings rate. So, I actually made a video a while back on how to calculate your savings rate and what kind of savings rates you should be trying to go for if you want to retire earlier or whatever the case may be. And then number three, which everybody knows, but it's just not always possible at all times for all of us, and that is to never carry a balance on a credit card. Because then, all of a sudden, that balance is going to be subject to their very high interest rates, which are typically in the 20% ballpark. And also, whenever you carry a credit card, then when you make purchases on the credit card, they start charging you interest from the day that you make the purchase. You no longer get that grace period anymore. So, this is a pretty common sense rule of thumb that everybody in the world would agree with. It's just not always possible for everybody. You know, shit happens. And sometimes, you have to carry a balance on your credit card to get yourself from point A to point B and you pay some interest. Hopefully, any debt that you're carrying between mortgages or student loans or car loans, you're under like 5% these days, maybe even under 4% on all those different types of debts. So, this one, I'm a fan of this rule of thumb. It is common sense. It's just not always possible. And sometimes, life just happens to get in the way. All right. So, now, number four is the rule of 72. And the rule of 72 is very helpful to try to figure out how long it will take your money to double, your investment to double. So, there's just a very simple rule that just makes it very easy without you having to do this crazy calculation to see how long it will take for you to double your investment. So, if you take, let's say, for example, you invest $10,000 into whatever, the stock market, the S&P 500, right? If you take your rate of return, your expected rate of return, and you divide that into 72, it'll tell you how many years it will be before that investment will double. So, let's look at some very simple examples, right? The simplest one is if you could get a 10% rate of return on your investments, then you could expect that investment to double every 7.2 years, right? So, 72 divided by 10, 7.2 years is how long it will take you for that investment to double. Let's go on the other end of the spectrum. If you sit your money in a money market account, and you get 1%, it'll then take you 72 years for that money to double. So, that is a pretty hefty difference. So, what if you could get a 4% rate of return? Then it's going to take you 18 years for your investment to double, right? 4 goes into 72, 18 times. And then what about 8%? 8 into 72 would be 9 years. So, if you get an 8% rate of return, it'll take you 9 years for your investment to double. So, this just shows you how important it is to get a high rate of return. Unfortunately, the higher rate of return you go for, the less chance you have of achieving it, right? It adds much more risk to the investment. So, 1% is very easy to obtain. It's just going to take you 72 years to double your money. 10%, you got to take a lot of risk to try to get 10%. All right. So, the next rule of thumb is for when you're looking to purchase a car, and it's called the 24-10 rule. So, the 20 stands for a 20% down payment. You want to be able to put at least 20% down on whatever car it is that you're purchasing. And then the 4 stands for how long of a financing term you should take on the car. So, a four-year loan or 48 months is the longest that you should finance the purchase of a car. And then the 10 stands for 10% of your gross income. So, you should only spend up to 10% of your gross income on the actual cost of the car, meaning the loan payment and also the insurance as well. All right. So, number six, and we're moving on to buying a house. So, a rule of thumb that you hear out there is that you could afford a house three times your gross annual income. And that's household income. So, if your household makes $150,000 a year, then a $450,000 house, that would be the ballpark as a rule of thumb. So now, with home prices like exploding higher over the last couple of years, it's pretty tough, right? Where I live, if you make 150 grand a year getting into a $450,000 house, you're typically paying more than that, right? It does depend. It depends on the area and what's going on. Also, another thing that I don't love about this rule of thumb is it doesn't take into consideration taxes. So, in my area, property taxes, they're pretty insane. So, if you buy a $450,000 house here in Westchester County, New York, the taxes are going to be probably triple than they will be if you're looking to buy a home in Memphis, Tennessee. So, this rule of thumb does not take that into consideration. But I guess overall, it's a good reality check. It gives you an idea of around how much house you could afford. Obviously, there are many other things that go into that deciding factor of how much house you should really be buying for yourself. So, all this stuff, you need to personalize this stuff, right? That's why I said in the beginning, you can't take these rule of thumbs and run with them. But I guess this one's a pretty good starting point. And then, keeping with houses, the next one which I find more helpful is the 2836 debt to income ratio. So, when you go to apply for a loan, you'll hear the mortgage representative talking about your DTI or your debt to income ratio. So, a typical debt to income ratio for your mortgage payment might be 28%. So, that's what the 28 stands for in the beginning here. So, let's just say, for example, you make $120,000 a year. So, that's $10,000 a month. 28% loan payment debt to income ratio would be a mortgage payment of $2,800 a month. And that would be for your principal interest, taxes, and insurance. So, your overall mortgage payment to be 28% of your total income. So, now, lenders, they will go beyond that. But that is a basic rule of thumb, 28%. And then, the 36, that is your debt to income ratio for all of your debt. So, not just your housing payment, but also if you have car payments, if you have student loan debt, credit card payments, whatever other debt you have should only be 36% of your gross income. So, again, if you make $10,000 a month, your total debt payment should be $3,600 a month to fit into these ratios. So, now, some lenders, they will extend this. So, you've seen that extended out to even like 50% debt to income ratio. That doesn't mean that you could afford it. That just means that the bank is willing to lend on it. But you don't want to put yourself in a stressful situation year in and year out to make your mortgage payment and to make ends meet. Right? So, staying within those limits, I think it's a pretty good rule of thumb. And then, for number eight, we're getting into investing for retirement. And the rule of thumb is that you take 100 and you subtract your age from it to get your asset allocation, to get how much, what percentage you should have in stocks in your investment portfolio. So, for example, if you are 40 years old, you take 100 minus 40, so you have 60. So, 60% of your investment allocation should be in stocks. The other 40% should be in bonds. Now, I don't like this rule of thumb at all. And it's actually evolved over the years. So, people, I think, now are using 110% minus your age. So, if you're age 40, 110 minus 40 gives you 70% allocation to stock and then 30% to bonds. But I don't use this at all. It totally depends on you and your specific situation, how you should have your retirement funds invested, what kind of asset allocation that you should personally have. All right. Number nine is the 4% rule. So, when you are in retirement, then you want to have a nest egg big enough where you only need to withdraw 4% every year to be able to make ends meet, to be able to live in retirement. So, now, this rule has been back-tested over many, many years and decades and has shown that if you only withdraw 4% of your account value every year, there's like a 99% chance, a 99% probability that you will not run out of money, that it will last you all the way through your retirement until you pass away. And you can also increase the amount that you withdraw each year for inflation. So, you start in year one with 4% and then you increase it every year by the amount of inflation. So, you do get a little bit of a raise every year using the 4% rules. And another thing is you have to keep in mind that we're talking about the gap of money that you need in retirement. So, if you have social security, if you're going to have a pension, you have to take all those things into consideration. So, let's say that you come to the realization that when I retire, I'm going to want to be able to spend $10,000 a month between traveling and living expenses and spoiling my grandkids or whatever the case may be, that you want $10,000 a month, right? So, that's $120,000 a year. But now, let's say that you're going to have social security between you and your spouse, which might be $50,000 a year, right? So, now, you have another $70,000 that is left. And let's say that you're going to have a small pension from a job. Like, for example, my wife, she used to be a teacher. She's going to have a small pension, let's say $10,000 a year, right? So, now, between social security and pension, we have $60,000 a year that we will have in retirement that will last us our entire lives. So, we have a $60,000 gap that we need to make up for, all right? So, according to the 4% rule, that means that I would need to have a nest egg, a portfolio of $1.5 million where I could take 4% per year, which is $60,000, increase it for inflation every year with the hopes that that would last me throughout our entire lives. So, that is the 4% rule. And it sounds like an overwhelming number, right? Because if you think, wow, if I save a million dollars, 4%, that's only $40,000 a year that I could take out of that. It's not a lot of money. So, I say that this is a good starting point. It's a good rule of thumb. It's a good number to shoot for, but it's not a hard number, right? Everybody's different. So, depending on how you live in retirement, all that stuff is going to come into play. Some people, they like to spend a lot of money right when they retire. You know, we call it like the go-go years right when you retire. Then you have the slow-go years where maybe you slow it down a little bit. And then you have the no-go years when, you know, maybe you're in your 80s and your 90s and you're just not really doing too much anymore. So, retirement spending, it's different for different stages of retirement. And it totally depends. But the 4% rule overall, I think it's a good starting point. It's a good rule of thumb. All right. And then the last one, number 10, is on life insurance. And the rule of thumb is to have 10 times your income in life insurance. So, if you make $150,000 a year, you should have $1.5 million in term life insurance. So now, if you don't have any life insurance and you have people that depend on you financially, if you have a family, then this is a very good starting point, right? You need to like run out and get life insurance as soon as possible so that you don't completely screw over everybody that you love in case the worst were to happen to you. But that's what it is. It's a rule of thumb. It definitely does not apply to everybody. And there's a lot of different things that go into making the decision of how much life insurance you actually need for your situation. So, I did do a video on this as well. I'll put a link to it down below to figure out exactly how much money you need in life insurance to protect your loved ones. But it is a good starting point. It is a good rule of thumb. All right, everyone. That is it for this one. Hopefully, you found it helpful. Go join my education center. My goal is to blow that thing up into an amazing resource, an amazing community, and I would love for you to be a part of it. I'm going to create a video in the near future going into more detail of what exactly it is in there. But go over to www.SchoolOfPersonalFinance.com and check it out. Thanks for being here. Hit that like button if you enjoyed this video. I'll see you again in the next one. Thanks.