Accounting On Us
Money rules of thumb
Ballpark figures for your financial plan
Michael Carlin, AIF
Financial planning rules of thumb are extremely helpful because they create an easy way for you to remember difficult financial concepts. However, what we typically find is they’re often misunderstood, misinterpreted or misused. So, we’re going to break down some important financial rules of thumb and talk about the best way to interpret them so you can optimize your own personal financial success.
Rule of thumb: at least 10% of your total income for your retirement
In many cases, the 10% savings rule is a good guideline because it creates a broad base for people to begin to understand how much of their salary or total pay they need to save every year. Without this rule, we find that many people often start saving a smaller percentage than 10%. You want to establish this rule of thumb as early as possible in your working career so that as you get raises and earn more over time, your savings amount automatically grows with your income.
Important note: You want to try to save 10% of your income for 30 working years. When we run projections for clients about how much they should aim to save, that 10% per year mark over 30 years tends to aggregate a long-term savings account value that can really help in retirement.
How much house can I afford and/or should I buy?
Rule of thumb: an amount equal to or less than 2.5 times your total combined income
If your total combined income is $200,000, then you shouldn’t be buying a house with a cost greater than $500,000. The problem with this rule is that it doesn’t take into consideration factors such as buying residential real estate property that is dramatically undervalued and would allow for greater long-term appreciation. We often support clients spending a little bit more on residential real estate when they’re buying properties at some type of deep discount.
Important note: Interest rates can change this rule of thumb a bit. They’ve been so low the past few years on a historical basis that mortgage payments may be more affordable with super low borrowing rates. This means people can borrow more and might be able to spend more than the typical rule of thumb allows. In cases with a low borrowing cost, some clients can manage a ratio greater than 2.5 times combined income. Maybe as high as three times.
Rule of thumb: 6 months of your household expenses
As financial advisors, we seek to help reduce the risk of unexpected financial disasters. Misfortune can strike at any time with job loss or sudden illness. This is why it’s important for you to have a financial cushion to help you through these traumatic events. A six-month cushion does provide a great sense of stability should something change suddenly.
However, saving six months of expenses in cash isn’t always feasible for every household. Striking a balance between the safety and stability of cash and long-term growth of investing your money is personal to each individual. In some cases, we may favor less because setting aside a big pile of cash in a bank account that’s earning little to no interest isn’t as favorable long-term. In fact, earning little to no interest over a long period of time, as opposed to investing your money in an account with a high rate of return, can be financially detrimental. The difference between earning 0.5% on cash and 7% in a growth investment adds up substantially.
Also, people in certain professions have greater income stability and predictability than others. If this is the case for you, we may recommend as low as three months of household expenses set aside in savings. That’s typically as low as we would recommend. However, if you find yourself in a profession that is paid based on sales or commissions, your need to hit a six-month household expenses target may be more important than someone who has greater job and income stability with a long-term track record of consistent earning history.
Percentage of stocks and bonds in your portfolio
Rule of thumb: the same amount as your age
The founder of Vanguard, John Bogle, created a rule of thumb that endures and resonates with investors all over the world. Essentially, Mr. Bogle said that you should have a percentage of bonds in your portfolio that is the same as your age. For example, an 80-year-old should have 80% of their money invested in conservative and consistent fixed income bonds. Similarly, a 25-year-old should have only 25% of their money invested in fixed income bonds. The remaining amount should be 20% stocks for the 80-year-old and 75% stocks for the 25-year-old.
We like this rule of thumb because it does help create an understanding of how portfolios should be more or less aggressive over time regarding your unique financial situation. Where we differ is that we believe a global tactical approach to investing can provide levels of diversification and balance to help weather difficult stock market environments over the long-term.
Now, not all situations are created equal. There will be some individuals who are more willing to accept portfolio volatility as they’re looking for long-term growth and can tolerate the ups and downs of the stock market. On the other hand, there are some investors who cannot endure market movements. They may make poor investment decisions if they have too much aggressiveness (reflected in very high stock exposure in their portfolio) and may need to be more conservative regardless of their age.
So, we would add to this that despite your age, you should take into consideration your investment experiences and long-term objectives before using this rule of thumb to determine your optimal investment allocation.
How do I get my financial questions answered?
Rule of thumb: contact your financial advisor
We hope you find these rules of thumb helpful and convenient. For further clarity on how these simple tips may relate to your situation, be sure to contact Henry+Horne Wealth Management.
Michael Carlin, AIF, is the President and Founder of Henry+Horne Wealth Management. He can be reached at (480) 483-3489 or MichaelC@hh-wm.com.
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