Rules of thumb are practical guidelines that provide simplified advice; they provide practical directions for completing or handling a specific task.
Every industry has its own set of rules and personal finance is no exception. Personal finance rules of thumb come from a variety of sources, some of which are tried and tested, some of which are old, and some of which are a little newer.
These guidelines should act as a guide on your personal finance journey; personal finance is personal, so it is completely OK to tweak some of these rules to fit your scenario; this will save you time and brain capacity.
You are essentially leaning on the wisdom and experience of others instead of reinventing the wheel.
Personal finance rules of thumb are an excellent place to start when it comes to getting your finances in order, so we’ve compiled a list of 31 finance rules of thumb.
These finance rules of thumb apply to everyone; if you don’t read any further or implement any other recommendations, these finance rules of thumb will suffice.
Paying yourself first is the most effective approach to saving money. The concept is straightforward: set aside a portion of your paycheck for savings or investments before spending the rest. To put it another way, make sure you save money before you spend it.
The only way to ensure that you will have enough money to retire comfortably and hit your financial goals is to pay yourself first.
Setting up automatic deductions into a savings or investment account is the simplest way to accomplish this. Begin with a small percentage and gradually raise it.
There are many finance rules of thumb for emergency fund but 3-6 months’ worth of funds makes the most sense.
Deciding how much money should you keep as an emergency fund is impacted by a number of things, including the size of your family, the amount of debt you have, and whether you are a one-income or two-income household.
In general, it is recommended that you save 3-6 months’ worth of living expenses as an emergency fund.
This rule prepares you for the unexpected, such as when your car breaks down or you lose your job.
With this fund, you won’t have to worry and make unwise decisions such as incurring debt or draining your retirement savings to cover your costs.
Learn more about emergency fund here
Getting life insurance is one of the most critical things you can do to protect your family. Term life insurance is a fantastic place to start because it is straightforward and inexpensive when compared to whole life.
Term life insurance is exactly what it sounds like: coverage for a set amount of time, such as ten or twenty years. You can choose how much coverage you want — say, £500,000 — and how long you need it for (e.g., 20 years), and it’s normally recommended when you get a mortgage.
This is one of the most important personal finance rules of thumb, it is referred to as living within your means. If you spend less than you make, you will have money left over at the end of the month to save and invest.
Your income should be used for more than just the needs of life. If you spend all of your money, you won’t have any leftover to save or invest.
Tracking where your money goes each month is the simplest way to minimise overspending. You have the option of using software, a spreadsheet, or plain old paper.
Regularly reviewing this information allows you to identify where your money is going and alter your expenditure accordingly.
At least once a year, review your credit report. It’s always a good idea to double-check that the information on your credit report is correct and up to date.
This financial rule of thumb indicates that you should spend 50% on necessities, 30% on desires, and 20% on savings. This is a wonderful place to start if you’re new to budgeting.
Learn more about budget here
This is the most effective method to stay within your budget; you can do it weekly if you are new to budgeting, or twice a month if you have been budgeting for some time.
A sinking fund is an excellent approach to save for future expenses that are not covered by your monthly budget. Examples include gifts, yearly payments such as insurance, and large expenditures such as a new car and holiday
Learn more about sinking funds here
This includes both grocery shopping and dining out.
This is one finance rule of thumb that helped us save quick enough to buy our first home in less than 2 years after moving to the UK.
The rule of thumb is that a family should live on one income, even if both spouses work. However, this is not always possible and it may require some creativity to make it work.
The obvious solution is to lower your expenses by cutting back on non-essential purchases, But those who are willing to be creative can often find other ways to save money without compromising their lifestyle.
For example, you might consider renting out part of your home (if you have the space) and/or getting a roommate or two. You could also take on part-time employment or freelance work in order to earn extra income while still being able to meet your financial obligations.
This rule shows you how long it will take for your savings or investment to double in value. Divide 72 by your investment’s interest rate to get this figure.
For example, if you invest £10,000 in the stock market with an average return of 10%, it will double in 7.2 years, whereas it will double in 36 years in a savings account with a 2% interest rate.
This is exactly how banks make money; they lock your cash in and give you between 1-2% while earning more than 10% with the funds.
Index funds are low-cost investments that mirror the performance of a certain market, such as the top 500 firms in the United States (S&P 500), and provide higher returns than most actively managed mutual funds.
Why do index funds outperform actively managed funds? Because they are cheaper.
Index fund managers do not invest in research teams, salary and commission payments or marketing initiatives, so they pass those savings on to you.
Start investing for retirement as soon as possible, ideally before you graduate from college. The longer you wait, the less time you have for your money to grow.
If you’ve already started saving but haven’t invested long enough, consider increasing your contributions to catch up sooner rather than later.
Learn more about index funds here
If you work a typical 9-5 job, this is the first step toward building wealth. You want to get as much free money as possible, and you do that by enrolling in your employer’s scheme; if your company is offering free money, take it all.
The 4% rule is a guideline for how much money retirees can safely withdraw from their savings each year without running out of money.
The formula is based on historical data and illustrates how much you might withdraw from your portfolio in 30 years without worrying about running out of money.
Learn more about the 4% rule here
Set aside 10% of your income for retirement. Many financial experts recommend saving at least 10% of your annual income for retirement until you reach retirement age (or close).
If you can’t afford that much right now, start with whatever you can afford and gradually increase it as your salary rises.
This rule was updated from 100 and states that the percentage of your investments in stocks compared to bonds should be 120 minus your age so if you are 30 today 90% of your investment should be invested in stocks and 10% in bonds.
Buying a home is one of the biggest financial decisions you’ll make. But it’s also one of the most important.
This rule will keep your payments manageable and ensure that you can save for retirement.
The rule of thumb for this is simple: If you spend more than 30% of your gross monthly income on housing, you may have difficulty saving for retirement or college for your children.
This can be particularly challenging in areas where property values are high like London.
Don’t buy a house until you’ve saved up enough money for a 20% down payment. A larger down payment on your mortgage will reduce the amount of interest you pay on it, which can build up over time and save you thousands of dollars in interest payments over the life of your loan.
The debt-to-income ratio calculates how much of your income is used to pay off your debts. This estimate takes into account credit cards, vehicle loans, mortgage payments, and other types of debt.
Most mortgage lenders recommend a debt-to-income ratio of 36%, which implies you should only spend 36% of your gross monthly income on debt repayment, but if you rent, you can substitute mortgage payments with rent.
Cost per use can be an efficient method of making purchasing decisions.
The calculation for “cost per use” is simple to learn. Simply divide the item’s cost by the number of times you anticipate using it.
For example, if you spend £100 on a new pair of shoes, wear them once a month, and they last ten years, the cost per usage is 83 pence. However, if you buy another pair for £20 but only use it once a month for a year, the cost per use is £1.67.
You can spend more money on a high-quality product that will endure for years, or you can buy a low-cost item that will break after a month.
Before making significant purchases, give yourself 30 days. This will let the excitement of a new purchase to wear off and allow you to determine whether the purchase is worthwhile.
You’ll wind up buying things you don’t need or want if you go shopping without a list.
Before you go to the store, prepare a list of what you need and stick to it! If there’s something else on sale that looks appealing, save it for the next time
These finance rules of thumb help keep your credit score high or improve them if they are bad
A utilization rate is essentially how much of your available credit you’re using at any given time — or how much debt you’re carrying around. Ideally, this should be less than 35%.
In other words, if your total available credit line is $10,000 and you owe $3,000 on that card, then your utilization rate is 30%.
Ideally, you should pay off all debt so that you don’t have any outstanding balances don’t let any of them accrue interest charges or fees
This guideline indicates that an automobile should be purchased with a 20% down payment, financed for four years, and the entire monthly cost, including fuel and maintenance, should not exceed 10%.
If you plan on keeping a car for fewer than four years, purchasing a new one is an expensive alternative that does not make financial sense.
On the other hand, if you plan on keeping your automobile for more than four years, buying a new one can save you money in the long run. Its recommended to use a new one for 10 years
This is a rule of thumb by the financial samurai blog that says that you should buy a car that is no more than 10% of your gross income
The idea that we should live up to our neighbours’ standards can be very damaging in our pursuit of financial success.
It can lead us to spend more than we can afford, take on too much debt or even buy things we don’t really want just because our neighbours have them and we don’t want to feel left behind.
Mind your own business. If you want to buy a luxury car, go ahead. Just make sure it fits into your budget and it supports your values and goals
Money is frequently regarded as a taboo subject, but this is changing. Make it a habit to discuss financial matters with your friends, family, and coworkers.
If you get a big tax refund or inheritance don’t blow it all at once Use 5% or less for something fun and put aside the rest into your goals and savings.
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