18 favorite financial rules of thumb (and some useful money guidelines)
Financial rules of thumb provide helpful shortcuts for making quick calculations and decisions. You don’t always have time (or want to take the time) to create elaborate spreadsheets when choosing a course of action. In these cases, it’s nice to have some rough guidelines you can rely on.
You’ve probably heard of the “rule of 72”, for example. This shortcut says that if you divide 72 by a particular rate of return, you’ll get the number of years it’ll take to double your money. If your savings account yields 4%, say, it will take about 18 years for your nest egg to increase by 100%. But if you were able to earn 12% on your investment, that money would double in six years.
Like all rules of thumb, the rule of 72 isn’t precise. It doesn’t give an exact answer but a ballpark figure. Financial rules of thumb don’t always hold true. But they’re true enough for us to make loose plans based on them.
I have some engineer friends who’d get tense at this sort of sloppy guesswork, but most of the rest of us are happy to trade a bit of precision for speed. That’s what rules of thumb are all about!
The trick, of course, is knowing which rules of thumb to use. Most are handy, but some common guidelines do more harm than good.
Rules Gone Wild
In the past, you’ve probably seen my rant about some of my most-hated financial rules of thumb. Let’s look at three things I think conventional wisdom gets wrong (and what I believe are better alternatives).
How much should you save for retirement?
For instance, I get frustrated when I hear financial advisers push the idea that you should base your retirement savings on 70% of your income. Instead of estimating your retirement needs from your income, it makes far more sense to base them on spending. Your spending reflects your lifestyle; your income doesn’t.
I think a better rule of thumb for determining retirement needs is this: When estimating how much you’ll need to save for retirement, assume you’ll spend as much in the future as you do now. Use 100% of your current expenses to calculate your retirement spending. (And if you want to build in a safety margin, base your future needs on 110% of your current spending.)
How much should you spend on a house?
As I mentioned last week, another rule of thumb that makes me cranky is this common guideline espoused by all sectors of the homebuying industry: “Buy as much home as you can afford.” No no no no no! Of all financial rules of thumb, this is probably the worst. It’s certainly one of the most prevalent. This is how folks end up house poor, chained to a mortgage they resent.
Lenders quantify this guideline by saying your housing payments should be nor more than 28% or 33% or 41% of your income. But, as David Bach wrote in The Automatic Millionaire Homeowner, “You should generally assume that the amount the bank or mortgage company is willing to loan you is more than you should borrow.” A better rule of thumb? Spend as little on housing as possible. Spending less than 25% of your net income is best — less than 20% is even better.
How much life insurance should you carry?
A third rule that bugs me is the one for determining how much life insurance you should buy. Different experts give different answers. Some say your policy should cover five times your annual income. Others say ten times. And Suze Orman recommends 20 times annual income needs.
The truth is that not everyone needs life insurance. Like all insurance, it’s designed to prevent financial catastrophes. You only need it if other people — like a spouse or children — would face financial hardship when you die. If you don’t have kids, if your spouse has a good income, or you have substantial savings, then life insurance isn’t a necessity.
Even if you do need life insurance, you probably don’t need to carry as much as your insurance agent is willing to sell you. To find out the amount that’s right for you, check out the Life Insurance Needs Calculator from the non-profit Life Happens organization. (How much life insurance should I carry? According to this calculator, I shouldn’t have any at all. And I don’t.)
Useful Financial Rules of Thumb
Financial rules of thumb usually aren’t this bad. In fact, most are useful. Here are eighteen of my favorites.
- When estimating income, $1 an hour in wage is equivalent to $2000 per year in pre-tax earnings. The reverse is also true: $2000 per year in salary is equal to $1 an hour in hourly wage. (This rule works because the average worker spends roughly 2000 hours per year on the job.)
- How wealthy should you be? According to the authors of The Millionaire Next Door, the following “wealth formula” can tell you if you’re on target: Divide your age by ten, then multiply by your annual gross income. Your net worth should be equal to this number (less any inheritances). So, if you’re 40 and make $50,000 per year, your net worth should be $200,000. If you have less than half the expected amount, you’re an “under-accumulator of wealth”. If you have twice the target, you’re a “prodigious accumulator of wealth“. (Note that the authors are well aware that this formula doesn’t work well for young people; it’s meant to be used by folks nearing retirement age.)
- On average, each dollar an American spends represents about $2.50 of after-tax value in ten years or $10 in thirty years. (If you live outside the U.S., the consequences of spending that dollar are probably even greater.) This is due to two reasons: taxes and compounding. When you buy something, you spend after-tax dollars. On average, Americans have to earn $1.33 to have $1.00 left over.
- Inflation is the silent killer of wealth. In the U.S., inflation has averaged 3.18% over the past hundred years. A lot of folks figure a 3% inflation rate when making money calculations. I think it’s safer to assume 3.5% — or even 4% — average inflation in the future.
- Historically, U.S. stocks have earned long-term real returns (meaning inflation-adjusted returns) of about 7%. Bonds have long-term real returns of around 2.5%. Gold and real estate have long-term real returns of close to 1%.
- If you withdraw about four percent of your savings each year, your wealth snowball will maintain its value against inflation. During market downturns, you might have to withdraw as little as three percent. If times are flush, you might allow yourself five percent. But four percent is generally safe. (For more on safe withdrawal rates, check out this article from the Mad Fientist.)
- Based on the previous rule of thumb, there’s a quick way to check whether early retirement is within your reach. Multiply your current annual expenses by 25. If the result is less than your savings, you’ve achieved financial independence — you can retire early. If the product is greater than your savings, you still have work to do. (If you’re conservative or have low risk tolerance, multiply your annual expenses by 30. If you’re aggressive and/or willing to take on greater risk, multiple by 20.)
- Building on the above, Mr. Money Mustache’s shockingly simple math behind early retirement gives us a useful rule of thumb for determining how long you’ll need to save before you’re financially independent. Figure out your current saving rate (or profit margin, if you prefer). Subtract this number from 60. Roughly speaking — and assuming you’ve started from a zero net worth — that’s how long you’ll need to work before your nest egg is big enough to support you in retirement. (Note that this rule breaks down at saving rates over 40%. If you save a lot, subtract from 70.)
- Joe from Stacking Benjamins likes what he calls the “penny approximation”: Assuming a safe withdraw rate of roughly four percent, every $100 you save gives you one penny per day in perpetuity. Once you stack enough Benjamins you have enough pennies to sustain you forever. If you change your own brake pads and save $200, thats two cents a day for the rest of your life because you avoided paying a mechanic.
- If you own your home, it’s wise to set aside money for maintenance and repairs. Each year, contribute 1% of your home’s current value to a separate account. If you don’t spend the money, keep it there for future remodeling and improvements.
- Is it better to buy or to rent? The price-to-rent ratio is a useful rule of thumb for making this decision. Find two similar places, one for sale and one for rent. Divide the sale price of the one by the annual rent for the other. The result is the P/R ratio. Say you find a $200,000 house for sale in a nice neighborhood, and a similar home for rent on the next block for $1000 per month, which is $12,000 per year. Dividing $200,000 by $12,000, you get a P/R ratio of 16.7. If the P/R ratio is low, it’s better to buy. If the price-to-rent ratio is over 15, it’s probably better to rent.
- How much does it cost to raise a child? As a rule of thumb, budget $10,000 per child per year. That’s not quite a quarter of a million dollars per kid, but it’s close.
- If you get a windfall, use 1% to treat yourself. (Or maybe 2%, tops.) Put the rest in a safe place and ignore it for six months. After you’ve had time to think about it, then take action. So, if you inherit $100,000 from Aunt Marge, only allow yourself a $1000 splurge. Stash the remaining $99,000 someplace you won’t be tempted to spend it.
- To approximate a new vehicle’s five-year cost of ownership (in monthly terms), double the price tage and divide by 60. Looking at a brand-new Mini Cooper ? Double that $30,000 sticker price to get $60,000, then divide by 60. Is it really worth $1000 per month to get rid of your crummy Ford Focus?
- The standard rule of thumb is to save at least 10% of your income. I think a better goal is to aim for 20% — and more is better. Financial guru Liz Weston says that if you’re young, you should follow this guideline: “Save 10% for basics, 15% for comfort, 20% to escape.”
- Nobody agrees how much you should set aside for an emergency fund. Even the experts offer advice ranging from $1000 up to 12 months of expenses. (The most common suggestions range from three to six months of expenses.) One clever rule of thumb to determine how much you should have set aside: Your emergency fund should cover X months of expenses, where X is the current unemployment rate. In other words, because the U.S. unemployment is about 4% right now, you should aim to have enough money in the bank to cover four months of expenses.
- According to Consumer Reports, wen you’re faced with the repair of an appliance (such as a refrigerator or washing machine), you should buy a new one if the appliance is more than eight years old (or if the repair would cost more than half what it would take to buy a replacement).
It’s important to remember that rules of thumb aren’t set in stone. They’re guidelines. They’re meant to help you make quick evaluations, not actual life-changing decisions. Financial rules of thumb are a starting point. Start with them, then adjust for your individual goals and situation.
Other Useful Financial Guidelines
Strictly speaking, rules of thumb deal with numbers. Still, there are a lot of non-numeric guidelines that I think are useful to know. If you’ve done any reading about personal finance, for example, you’ve probably heard the admonition, “Pay yourself first.” While not strictly a rule of thumb, this guideline is very similar.
Here are some other useful financial guidelines:
- The more you learn, the more you earn. In the U.S., education has a greater impact on work-life earnings than any other demographic factor. Your age, race, gender, and location all influence what you earn, but nothing matters more than what you know.
- Bank a raise. When you get a salary bump, don’t increase your spending. Stay the course and put the added income into savings.
- Always take the employer match on the 401(k).
- Never touch your retirement savings — except for retirement.
- Never co-sign on a loan. (Ever.)
- Avoid paying interest on anything that loses value. It’s okay to finance a home or a college education but avoid taking out a loan on a car.
- Speaking of cars: When you buy a vehicle, buy used or buy new and plan to drive it for at least ten years. (Do both and you’ll save even more!)
- Don’t mess with the IRS. When it comes to taxes, don’t try to cheat. Pay what you owe. Claim all the deductions you deserve, but don’t try to stretch things.
- In general, save an emergency fund first; pay off high-interest debt second; and begin investing (at the same time you pay down remaining debt) last.
- It almost always makes more sense (and cents) to repair your old car than to buy a new one.
- If you’re not willing to pay cash for it, then it doesn’t make sense to buy it on credit. (I have a friend whose guiding principle is: “If I wouldn’t buy five, why would I buy one?” Similar idea taken to an extreme.)
- Save for your own retirement before saving for your children’s college education. They can get loans for school. You can’t get loans for retirement.
Now it’s your turn. What rules of thumb did I miss? Do you disagree with any of those I suggested? What are some of your favorite rules of thumb?
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There are 51 comments to "18 favorite financial rules of thumb (and some useful money guidelines)".
My apologies to folks who commented earlier today. Those comments are lost. I managed to nuke my WordPress install somehow and had to reinstall a backup that pre-dates the original publication of this article.
Hi JD,
Thanks for a really great article.
Yes, you missed a biggie:
Put God First in all areas of your life, including your finances. If we keep an “It all belongs to Him and He is providing it” attitude, it helps us to keep appreciation and balance. Giving to the poor, or God’s work is essential. Tithing, (giving 10% of what comes in the front door) works miracles in so many ways.
In my almost 40 years of financial planning for thousands of families, i can personally attest to the benefits for not only a families finances, but also their marital and family peace and sense of mission.
Amen Peter Jackson
Agreed 110%. He has blessed our marriage, three children and of course our finances!
Um, and for people who follow other faiths or no faith at all?
That’s a personal decision, not a financial one.
Hi Ishtar,
I didn’t mention any faith in my post. The point is having humility, compassion and gratitude which in real life translates into peace within, having a willingness to live within ones means and being willing to help others less fortunate than oneself.
It is true that financial decisions are personal. How we allocate our funds reflects our personal values, whatever they are.
Laws of finance:
The only situation better than having money in the bank is having CASH (NOT credit cards) in your wallet.
The necessities of modern life : food, clothing, shelter, transportation, education, and medical care. One can buy too much of ALL of these, and waste money. The only exception is education. One can never have too much education.
I’m a fan of the old “Wealthy Barber” rule of thumb:
“A penny saved is two pennies earned.”
(I.e. if you save a penny, it’s worth the same as earning 2 new pennies when you factor in all taxes, etc. It’s not exactly right at all — probably more like a penny saved is 1.33 pennies earned — but it stresses that reducing expenses and/or saving and investing your after tax money is way better than getting a raise)
“To approximate a new vehicle’s five-year cost of ownership (in monthly terms), double the price tage and divide by 60”
I vaguely remember hearing of this one somewhere but why not just divide by 30 instead of doubling and then dividing by 60? It’s the same result. I believe this is an example of the “Associative Property” where you can multiply numbers in any order.
Yeah, I thought that was funny at first too before I realized that the “divide by sixty” thing is meant to tie back to the five years (which is sixty months).
Not sure I agree with this rule as your car should still have half of its value after 5 years, so still paying $500 a month for a new Mini is not very logical but not as severe as $1000 a month. I agree with the point that the first 5 years have the highest depreciation.
This one is not so much a rule of thumb, as it is a way of viewing ones investments.
People mostly gauge the health of their retirement savings by checking the balance throughout their working years. The problem with this approach is it uses current market value as a measuring stick, and we all know how volatile the market is.
When saving for the long term, the only prices that matter are the purchase price and the sale price… every price in between is just background noise. In fact, if you are dollar cost averaging by adding to your savings each paycheck as most people do, then you are actually better off when there is a market downturn, since you are able to purchase more shares.
A better way to measure the health of a retirement account during ones working years would be to look at the total number of shares owned. Once people realize they are actually able to add MORE shares to their portfolio when their is a market downturn, since stocks are cheaper, they may actually be less likely to panic and make many of the mistakes amateurs commonly make, such as selling during market downturns.
Just a thought.
I’m a numbers nerd, so I acknowledge it would be boring to most people, but I’d be interested in a discussion of emergency fund size vs wealth and investment strategy. As i have saved more money my emergency fund has shrunk bc in a real emergency I would have all of my investments to fall back on. Therefore I have investments and I have cash and I occasionally consider which investments I would liquidate first.
I still have an account I call my emergency fund, but mostly because I’ve been too busy to restructure in a while.
How much cash to hold? Interesting question. I read this NYTimes article with great interest—I was totally surprised by how much cash is held by billionaires, since, like you, S.G., I tend to keep our money working for us as much as possible (time in the market). The billionaires’ high cash holdings might be due to a sense of increasing caution when one approaches that level of wealth, or it might be reflective of a need for cash flow in their businesses. See this: https://www.nytimes.com/2017/02/19/your-money/where-the-worlds-wealthiest-invest-their-billions.html
We are FI–but not joining the 3 comma club. Our cash holdings (ie. Emergency funds) vary over time. I have a secure job and my SO is retired with RMDs and SS, so we have solid streams of income and frugal habits.
After automatic retirement investments, I use our cash/bank account to trap excess capital, and then we make large scale purchases from that (post-tax equities, contributions to our charitable fund, home improvements, or travel).
Therefore, our cash fund constantly fluctuates. I keep the floor at about four months of expenses, and I know I have to make decisions/purchasing/planning when it edges higher.
Planning for my own retirement in 18 months has got me looking at research on the preservation of principle in the first decade of retirement, so I am constructing a CD ladder that will bridge us with income until I have to take my own RMDs/SS. That ladder will increase our % of cash holdings to about 7% of net worth (n.w. excluding home, at outset of retirement). I’m comfortable with that as an insurance policy that also gives us room to maneuver around unexpected challenges in those crucial first years without the regular paycheck.
But everybody has a different risk tolerance…
PS….the only problem with thinking of investments as your emergency fund is if you have to sell during a market downturn. Ouch. In that case, if you are well-diversified, you can sell something that has appreciated (and/or sell something that has depreciated so you can take a tax loss).
Keeping maximum capital in the market (as opposed to cash/CDs) does maximize returns. But it can hamper flexibility in the event of sudden change (like a market downturn when you want a bunch of cash on hand to buy at fire-sale prices). There’s no perfect answer, so find your middle and aim there.
Didn’t know there are so many rules! Going to follow some of them!
Not gonna lie. I don’t follow rules (too conflicting and confusing, and approach it like I approach nutrition and food science…immense skepticism that it applies to me).
I am in my mid 30s and have never calculated my retirement. I simply do the best I can.
There are so many unknowns and I think “what’s the point?”. I don’t know if or how much inheritance I’ll get before the end of my life. I don’t know if I’ll have costly health issues. If I’ll marry someone wealthy and generous…or not in a great financial position.
I am already doing the most. And for me, the most is taking as much care for the future as I can without encroaching on my satisfaction with the present. The rules won’t change my actions, and might possibly just stress me out.
Plus I think most of them just look good on paper. I don’t dare base my future expenses on what I spend or earn now, because I intend for both categories to fluctuate. I’ve been in “hustle mode” most of my working life so far, and I plan to slowly step away from that as I increase my passive income.
I plan to decrease my financial obligations, but at the same time increase my discretionary spending. The ratio of that will depend on what Incan afford to do.
So my personal rule is, do what I can, and be flexible and creative around what I eventually have to work with. The only time I can see myself attempting to calculate future costs and income needs, is whenever I am about to make a transition that will affect me financially (such as reducing work hours, or deciding if I want to stop working full time).
Other than that, I will continue to plan my goals 3-5 years out. That way it forces me to engage with the most updated reality, and not continued on a trajectory based on some rule I began to follow years ago, which may no longer be valid.
Seems reasonable, but I think it’s good to know what the “optimum” solution might look like. I guess that could stress you out if you are coming up short, but it definitely improves your outlook if you are ahead.
That seems like a risky strategy to me. By the time you get along far enough toward retirement, if you realize you are coming up short, you don’t have many options by then to correct course. When you say, “I am already doing the most…for me, the most is taking as much care for the future as I can without encroaching on my satisfaction with the present. The rules won’t change my actions, and might possibly just stress me out,” sends up a huge red flag. You won’t have much satisfaction with your future present if you don’t save enough now. “Satisfaction with the present” can be an excuse to overspend. You must save at least 20% of your gross income in order to reach a comfortable retirement, and you should find a way to be satisfied with what’s left over. These rules of thumb are critical for providing the guidance you need. My husband is retiring on June 1 at the age of 54 precisely BECAUSE we followed specific rules of thumb: Pay yourself first, save 20% (or more) of your gross income, dollar cost average, buy and hold low cost index funds, when you get a raise or a bonus save it (or most of it) instead of spending it, buy as little house as you need, not at much as you can, collect any 401K match, etc. We opened 529 plans when our sons were born and paid for their college educations. We encouraged them to save by matching their savings in Roth IRAs when they were in their teens. They are both now in their early 20s, have no college loans, and have already accumulated about $50,000 each. It helped that both of our parents paid for our college educations. What an incredible gift we were given. It allowed us to start saving significant amounts of money when we were young and before we had kids. Making sure we could still save at least 20% of our gross income guided how much we could spend on a house, on cars, on vacations, etc. So I strongly urge you to think long and hard about what rules of thumb you should follow if you want financial independence. If it turns out you did a better job than you thought you could, then that’s a bonus that allows for more discretionary spending in the future, and perhaps an early retirement.
Hummm- the education rule. Maybe it is true for the 5% who go into computer development, doctors, some engineers. I think the rule should be amended to: “Education, and the profession you choose with that education, is the best indicator.” Maybe even, “Education and the networking you gain in college…. ”
We are a household of two Masters and one Bachelors (+a zillion other hours of grad work). Our professions never helped us gain lots of money. We are retired and enjoying a middle of the road retirement. I know a number of struggling associate professors, who would have been financially better off teaching high school.
My brother in law is a mechanic (high school shop). No college. My sister got a business degree around 40. They turned a job into a business. They are very skilled at sales and personnel. Now they are very successfully FIRE.
My husband’s brother and his wife never went to college. They, even after raising five kids and putting them through college, are very successfully retired (although he loves his side gig of being a repair man).
Really, it comes down to gumption and relationships. What are you going to put forward to get out what you need/want? Find your strengths and work those to the fullest. A good sales person in the US makes more then most doctors in short spurts.
The world is changing very quickly. We have no idea what type of “education” will get people the furthest in the next twenty years. Preparing this next group to THINK is the most important part of their future.
Was it your specific education or your gumption/relationships that made and sold Get Rich Slowly?
“Avoid paying interest on anything that loses value.”
I agree. It seems education needs it’s own corollary, not just for financing, but for ROI in general. That gets pretty complicated, but it’s pretty safe to say outside of medicine, law, and maybe engineering, that an undergrad diploma from a high cost private university is a waste of money. But then you layer in whether you plan to go to graduate school (or should), networking opportunities, participation in funded projects, and your own motivation and business sense and it gets complicated.
One thing for sure, if you aren’t good enough to get tuition waived or compensation for your projects or other on-campus work such that you don’t need to borrow money, you shouldn’t be doing grad school. At best, you just aren’t very good at the subject. At worst, you’re paying for something that society doesn’t value, which is fine, but doesn’t support a goal of financial independence.
Consider purchasing an investment property if it’s annual rent is greater than 1% of its purchase price.
So a 200K house which fetches 2K a month, get 24K a year and that is 24/200 = 1.2% and therefore worth considering as an investment.
I meant to say consider purchasing if monthly rent is greater than 1% of purchasing price
EXCELLENT list! I work with seniors in high school and part of that training is “welcome to the real world”. Your rules are great tools for them to understand what it means to plan. Sure, everyone’s life is different, but at least looking at different scenarios makes a difference. Keep up the GREAT work!
How the hell is someone with a 50k/annual job at 40 supposed to live and have a net worth of 200k??!! Life is expensive and not getting any cheaper especially if you live in a large city. Very few people now are given the right start in life financially and can’t afford a house, a car, student loan payments (which will be made well into your 30s), children (child care alone costs well over $1500/month!!!), much needed vacations, if divorced – alimony, food, gas, electric and heating bills (in some places can be as much as $1000/month). That right there is every single dime made.
Rules of thumb are fantastic when you actually have money. Sad reality is that most don’t.
And yet, Barb, lots of people do have net worths of $200,000 (or more!) at age forty with a $50,000 salary.
I understand where Barb is coming from. We all have different experiences and factors at play. I’m 39 and would have 200K net worth had I not had almost $100k in debt at 30. My husband and I finally got educated and are debt free at 36. But that’s ten years of not saving and investing all because of lack of financial literacy and student loans. That’s why I started Alumni360.org – a mentorship group for students from low wealth areas. We need to give them this info (and how to fund college with no or low loans) before they get in a world of financial hurt.
I like your list J.D and now, in addition to my normal job of teaching elementary music, I teach financial classes to minorities, women and youth – because the disaster from ignorance needs to end.
The only other thing I would add is LOOK AT THE FEES of your investments. My school contracts with a company, I’ll call them PM Company, and they charged us 2% in fees plus a $50 annual fee to manage a 403B. I contributed $5500 over the last 6 years and they charged me $2100 in fees. They target ignorant teachers and lure us in with donuts and juice and tell us to sign on the dotted line, knowing they are raking us through the financial coals. It’s sad and needs to stop.
My parents were unable to help me with college and getting that start in life, so I had to make sacrifices that I wish I could have avoided. I worked fulltime and went to college parttime and took a degree that lead to a career that paid well, rather than one I found of great interest. It took me 8 years to get a 5 year degree, but I was able to graduate without debt. And, that boring degree got me a good job and making choices to delay marriage meant no expensive divorce and delaying having children meant I could build savings early and take advantage of compounding interest.
I for one, am grateful for articles like these, and especially for people with less resources. I feel that we are/were the ones who needed this advice the most.
That “lots” is far from the majority I imagine. Barb, I’m right there with you. But the fact that we are reading these kind of sites and trying to make the best of what we have counts for something. I went from a disastrous 18 year marriage as a stay at home parent, many years my ex earned a 6 figure salary, but we zeroed out after almost every pay period. After bankruptcy in 2012, separation in 2014 and divorce in 2016 I have my finances in pretty good shape considering. I’m chipping away at the last of my credit card debt, I have a small emergency fund started, and will be purchasing a home close to my work where I can afford to live after my alimony ends. Vacations that involve air travel or hotels are not in my future, no inheritance coming either, but buying my next car with cash… that could happen.
Kudos to you!! Women always need to be prepared. Keep up the good work!
Deobrah,
I am so very glad it worked out that way for you after 21.5 years of marriage and being a stay at home wife and parent I got left with 180k of debt and 150k in alimony.
Nothing to buy anything for my needs and no schooling paid for either. I tell all ladies to protect themselves up front he even took my bank account.
Whoever thinks it’s cheaper to repair an old car than replace it with a new one never owned a car whose parts started to wear out at a certain age — no sooner do you repair/replace an old part, here comes another breakdown.
This is a little like hearing someone bitch, cry and moan over “the servant problem.”
This is an interesting article, but I think it would be very dangerous for anyone to expect to get average returns of 7% from the stock market in the future. I would use 4%. I realize in the past it was about 7%, but I think the game has changed. Maybe some day it will change again and get back to 7%, but betting your financial future on 7% returns is very risky now.
I totally agree. Everyone seems to agree that stocks are risky, but everyone also seems to agree that they will return 7-8% in the long run. In which case stocks aren’t really risky.
You have to have a long enough investment horizon. Those are historical averages and over the course of 40 years or so, they prove quite robust – but you have to stay invested. The run-ups aren’t predictable and if you are out of the market during the few days when the run-ups happen, you won’t realize those long-term averages of 7% or so. During the last major stock market downturn, we lost about 60% of our total value on paper, but since we didn’t have to sell, the market has rebounded and gone on to even greater returns. And it was a good time to buy more shares.
I really enjoyed your post on the rules of thumb to get rich slowly.
One that I quote often to my kids and grandkids is:
Spend less than you make.
Make it before you spend it
This is credited to Thomas Jefferson, but I haven’t checked it out.
This is a great list! I especially love #10 about budgets. I feel the same way. My favorite money rule of thumb is “count your pennies and the dollars will take care of themselves.”
I am a CPA and I retired thirteen years ago. I set some goals when I was 30 and they led me to retirement at 56 and a comfortable life since.
Do not retire with a mortgage or a car payment. You get a fifteen year mortgage and try to pay it of early. No second mortgages, no refinancing or any kind of cash out. You should at least be able to pay off two fifteen year mortgages between the ages of 30 and 60.
Get a three year car loan (if ya can’t afford the payments on a three year loan you can’t afford the car, buy a less expensive one). Keep that car as long as possible. Open a savings account and continue to make payments into that account forever after the car is paid. When you need a new car you should have more than enough cash to make the purchase but keep making those payments.
Do not be married when you retire. There is an $18,000 marriage penalty on the taxability of Social Security each year if you are married as opposed to two single taxpayers. Ask your congressman why.
Pay your credit card(s) off every month. No excuses.
DO NOT BE MARRIED in retirement???? Wow! That’s a first! LOL 🙂
Other than the Do not be married advice, I agree with virtually everything you said.
Your $18000 penalty is misleading. A married couple has to pay taxes on up to 50% of their social security earnings if making over $35k per year while singles is $25k/yr, thus the unmarried couple limit is $50k for a difference of $18k. If a couple is only making $35-$50k per year in retirement from investments, then they probably weren’t high income earners and probably received at most $1500/mo each on social security for a total of $3000/mo or $36k/yr. Thus if 50% of this SS is taxed at your rate of 12% that is a penalty of 50%(36k)*12% = $2040.00. This is still unfair, but not the $18k you suggest.
Assuming max SS payout would be $3016/mo at full retirement age so for maxed out couples it puts the combined income at $72k plus investments which would require all couples to pay the same pay taxes on 50% of their SS, or ~12%of 50%(72k) or ~$4040 more taxes.
I think item 15 is outdated. There are almost never major repairs on a new car within 5 years, so doubling the purchase price is way too much. And all of the other costs are pretty close to what you pay for the existing car (more expensive service on the new car, but more repairs on the old, assuming you keep it in nice operating condition). Sure, insurance and car tags go up a bit, but fuel cost probably goes down a little. I’d think 1.5 times is more realistic for incremental additional cost. Matter of fact, I daresay 1X is more accurate than 2X if you assume trade-in of the old car pays sales tax on the new.
Obviously, we are assuming no financing/leasing.
Where does this come from: “Gold and real estate have long-term real returns of close to 1%.”? Real Estate prices are increasing rapidly in the western states and appear to be larger than 1%.
This comes from historical data. Leaving aside the wackiness of the last fifteen years, real estate tends to appreciate at just above the level of inflation. The last fifteen years have been strange, though, and the numbers are way out of line with the previous century.
One thing that I would add as critical for people in debt: use your interest payments on your debt to estimate the value of recurring payments.
So like I have $5k on a credit line which charges me about $40/month interest. This means that $10/month is literally worth $1250 present dollars right now: I can borrow $1200 and it will cost me $10/month for the foreseeable future. The indefinite future is literally the next 120 months. That really helps on questions like “is Netflix worth this much? Audible? Plated? Would I spend this much money, right now, for a lifetime subscription?
It also highlights that this does the exact opposite that you’d expect with worse credit: your breakeven becomes shorter-term not longer-term. A heftier credit card would probably charge me twice as much in interest and my indefinite future becomes only 60 months long, Netflix becomes less expensive overall. You probably would want to divide by a salary or so though, to get a clean comparison between people like that: lifelong Netflix for $600 sounds really nice from my lofty perspective but that’s because I have privilege which I need to check when I’m thinking about other folks.
Very nice rules! If everybody knew them and followed them, there would be much more wealthy people! Thanks J.D. !
This is one of my favorite posts of yours! Great kernels of wisdom.
Very helpful rules and guidelines that really help anyone no matter what stage of the financial cycle they are in.
Thanks for putting it altogether in one convenient place.
The one thing I would add to the list. If you ever loan anyone any money for any reason at all. Get it put in writing that they have to pay you back (get this drawn up by an attorney) Do not loan unless they are willing to sign.
If you get married keep what you have seperate do not co mingle your funds that you had prior to the union. If you do that is the same as loaning someone
else your cash in divorce you do not get comingled back.
Keep seperate bank accounts or better yet don’t get married.
Unfortunately, just living together for a minimum of 6 months is equivalent to being common law or the same rights as married in a lot of places. I agree with the other aspects of signing for loans to everyone. Everyone should have their own separate account as well as a community account. Having previously been married and now widowed the last 12 years, I am in a position to marry again, but at 59 I am going for the money and will wait til I am 60, file for my wife’s SS benefits that she paid into and is no longer around to collect. Then I can freely marry without losing out on the benefits. I will still be working for a number of years til I retire, as I never did get serious early in life with my finances and plan for retirement.
100%-110% of present income need is too much, especially for “prodigious” savers since one of our biggest “expenses” every month pre-retirement is savings. If I don’t have to save 25% anymore, my cost of living will be much lower.