Although not hard and fast, rules of thumb can be quite helpful with making decisions and achieving goals. You may have rules of thumb for finding a job or going to the grocery store. How about financial rules of thumb? These will help you manage your money and reach your financial goals.
For most people the 50/30/20 rule works well. With this, 50 percent of your income goes to necessities like housing and bills, 30 percent goes to “wants” like dining or going to see a show, and 20 percent goes towards reaching financial goals such as saving for retirement or paying off debt. In most situations, this creates a workable balance better present needs and wants and long-term goals.
Buying a Car
Other than a house, for most people buying a car is their biggest expense. Assuming you have a reasonable commute and decently paying job, the 20/4/10 rule is the way to go. Put down 20 percent of the cost of the vehicle and finance the rest for no more than four years. Overall, you should aim to spend no more than 10 percent of your gross income on transportation. In most situations, this ensures you don’t buy more car than you can afford.
Buying a Home
This one is a big deal – and a big commitment. Most people own their homes for at least five years. To help avoid added costs such as PMI, put down at least 20 percent of the purchase price. In addition to keeping your mortgage costs lower, it also helps ensure you don’t sign up for a bigger mortgage than you can handle.
No one wants to work forever. Unless you’re nearing the retirement age, putting 10% of your income towards retirement is a simple number to work with and ensures money is regularly being set aside.
Another way to figure out how much to set aside for retirement is to work backwards. You should set aside 20x your gross annual income. Thinking about it this way gets you focused on the future and helps you back into how much you need to set aside with every paycheck.
Saving and Investing
Emergencies happen. To protect yourself from financial disaster in the case of a crisis, aim to have at least 6-months of income readily available. Although having so much money in low interest accounts can feel like a missed opportunity, you’ll breathe a sigh of relief if you need it quickly.
Although these rules of thumb don’t work for every financial situation, they’re a good starting point, especially if you’re struggling to figure out a money management strategy.