Financial Rules of Thumb Make Me Angry

Financial Rules of Thumb Make Me Angry

When you do what I do, you get asked about financial rules of thumb a lot.

You know what I mean.

  • “How much should I spend on housing?”
  • “What’s a good amount to spend on entertainment?”
  • “How much should I be saving for retirement?”

Those are all great questions that most certainly need answers. However, those answers need to come from you. 

Only you can decide how much you should be paying for housing or spending on entertainment or saving for retirement.

You’re the one with the financial goals that are specific to you, right?

It’s those financial goals that will help you decide which items you want to fund in your budget based on your priorities.

I realize it would make things easier if you could just follow a rule of thumb and everything would end up perfectly. But that’s not how life works. Stop trying to take the easy way out.

You need to realize that these “rules of thumb” are just generalizations; they assume that everyone fits into the same mold.

That’s just not true. You’re NOT like everyone else.

Let’s look at a couple financial rules of thumb and I’ll show you what I mean.

“How Much Should My Rent/Mortgage Be?”

You’ve probably heard some of these already:

  • “Aim for a house that costs less than two-and-a-half times your gross salary.”
  • “The mortgage payment (principal, interest, taxes and insurance) plus your other monthly debt payments shouldn’t be more than 43% of your gross income.”
  • “Don’t spend more than 25% of your budget on housing.”
  • “Don’t spend more than 30% of your budget on housing.”

Nope. The last two are not a mistake.

I didn’t get anything mixed up.

There are differing opinions on the percentage of your income to spend on housing. That alone should tell you all you need to know about rules of thumb, but I’ll continue.

What you can truly afford depends on your goals. 

For example, let’s say your financial goals prioritize traveling. Because of that, maybe you’re willing to sacrifice some housing comforts to meet them.

You could move in with a roommate and split the rent and utilities which let’s say comes out to 15% of your income. Maybe the difference between that and the “25% of your income” rule of thumb allows you to meet your traveling goal.

If you just would have went with the rule of thumb, you wouldn’t have been able to travel. Or worse, you would have spent 25% of your income on housing, still traveled, and then ended up in debt.

Oh and on a side note, the second rule in the list is actually for the mortgage company, not you personally. The result of that equation is typically the largest payment the mortgage company would allow you to have. Unfortunately too many people take the result of this equation as what they can afford and that’s just plain risky.

Anyway, here’s my recommendation on how to decide what YOU should spend on housing:

Determine your financial goals and integrate them into your annual budget. As you’re adding all of your other expenses to the annual budget, leave the housing section blank.

After you get everything entered, including maintenance and repairs if you’re buying a house, you can see what’s left over and base your decision on that. You’ll have an actual amount you could afford.

“Recommended Budget Percentages”

There are plenty of recommendations on how to set up your budget.

Maybe you could use the 50/20/30 method where you allocate 50% of your income to fixed bills, put at least 20% toward your goals, and then use 30% for the discretionary stuff.

Or you could use these generic guidelines.

But once again, these stupid rules of thumb try to throw you in the same mold as everyone else. You need to break out of that mold.

Remember that only you can decide how much you want to spend in certain categories.

Want to cut back on the majority of your expenses and save 50% of your income so you can retire early? Do it.

Want to use that extra money to travel? Make it happen.

Want to buy a latte every morning on your way to work? As long as you can still meet your financial goals, who cares!

You just need to do the work and decide how much you can actually spend/save each month.

If you don’t put in the work, you’re going to want to do it all and will most certainly end up in debt.

“How Much to Save For Retirement”

Ahhh, the magic number; the amount of money you should be saving for your retirement.

What have you heard when it comes to retirement?

  • “Save 10% of your income!”
  • “Save 15% of your income!”
  • “Have $1 million in your 401(k)!”
  • “At the age of 60, have 6 times your salary saved!”

With so many possibilities, it’s no wonder the majority of Americans are not saving enough for retirement.

When it comes to saving for retirement, in my opinion you’ll be in one of two boats. 

You’ll be in boat #1 if you know when you want to retire, where you want to live in retirement and what you want to do in retirement. 

If you know the answer to all of those questions, you need to go talk with a licensed CERTIFIED FINANCIAL PLANNER™ professional.

That financial planner can take the information you give them and let you know how much you should be saving to make sure you meet your goals while also not running out of money before you die.

I recommend using a financial planner that only gets paid by the hour. That way you can be confident they’ll give you unbiased advice.

If you’re not in boat #1, you’ll be in boat #2. That means you don’t know what the answers are to all three of those questions.

If you’re in boat #2, my only advice is SAVE AS MUCH AS YOU CAN.

Trust me, I wish I could tell you exactly what you need to save. Unfortunately if YOU don’t know what you want to do in retirement, there’s no one that can give you a ballpark figure on what you need to save.

If you save as much as you can, I’m hopeful that one day when you give the answers to those questions to a financial planner they can tell you that you saved WAY too much for retirement. 

That’s a better answer than you haven’t saved enough and you can’t save enough.

If you’re in boat #2, it still may be beneficial to go and talk with that hourly financial planner. They can make sure you’re saving in a tax-efficient and low-cost way.

“How Much to Save For Your Emergency Fund”

“Save three to six months for your emergency fund!”

This is one of these rules of thumb that has been around for years.

Don’t get me wrong, having an emergency fund is a very important piece of a sound financial plan. But why only three to six months?

Looking at the list of TRUE financial emergencies, you can see that there are 5 categories.

In order to find what YOU need to save for emergencies, you need to evaluate how susceptible you are to each and every one of those scenarios. 

For example, if you’re in an industry with a history of unexpected layoffs you may need to save MORE than six months of your expenses.

But if you work for the federal government, you may not need to save as much.

Determine how susceptible you are to the 5 types of true financial emergencies and set a target amount to save.

Make Your Own Rules of Thumb

Personal finances are just that, personal.

I wish I could tell you that there was a magic formula where you could input all of your financial information and know exactly what you needed to do and when you needed to do it.

Unfortunately that doesn’t exist.

You need to take this opportunity to understand your finances and figure out where you want to go. Take that first step today.

Just remember – your finances will be with your forever. Make sure you take care of them.

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