Whether you’re trying to get your spending under control or your money growing, finance rules can be confusing. How much pay should go into savings? Am I saving enough to be comfortable in my retirement? Will my current investments get me to my financial goals?
While there are no hard and fast rules to guarantee you’ll pay off your debts in a year or become a billionaire, these eight rules of thumb for budgeting, spending, saving and investing will help set you on the right track.
Rule of 72
This is a general investment rule that outlines when one might expect to double an investment. Divide 72 by the investment’s annual rate of return and the answer is the number of years it should take to double your money.
Canstar says that for an even more accurate number, use 69.3 as the base number. This rule has been around for many years, predating everybody having smartphone calculators in their pockets, and it’s believed 72 was originally used as it was easier to work with in your head.
Now, a budget based on getting to zero may sound counterintuitive, but it’s really about assigning a role to each dollar you earn before you spend it.
The idea is to break down your monthly (or fortnightly or however you receive your money) expenses, including any debt payments or discretionary spending money, and subtract it from your after-tax income.
The remaining amount goes into savings, giving you a remaining amount of zero. It gives every dollar you earn a role and can really help rein in out-of-control spending.
Rule of 25 for retirement
Another guideline that has been around for donkey’s years is the ‘rule of 25’ for retirement, which is meant to determine the savings target to reach if you’re to have a comfortable retirement.
Work out a detailed budget of your yearly expenses (excluding anything you normally put away for saving) and multiply the total amount by 25. This figure is the nest egg you’ll need for a retirement that suits you.
The 50/30/20 budgeting rule
As a solid rule of thumb for organising your household finances, 50 per cent of your post-tax income each month should be reserved for living expenses (mortgage/rent, food, bills), 30 per cent for discretionary spending, and 20 per cent towards saving and investing.
This is a very general rule that doesn’t really take into account individual circumstances. The key is to adjust the percentages according to your needs.
For example, somebody saving for a house deposit may wish to save more than 20 per cent each month. If you live in a high cost-of-living area, then your expenses may be more than 50 per cent and if you’re on a low income then spending 30 per cent on discretionary items may be unrealistic.
Six month emergency fund
Building a rainy day emergency fund is always a good idea, but the COVID-19 pandemic has made having some spare cash on hand an absolute must.
In fact, the old rule used to be to put enough aside to cover three months of expenses, but the events of the past 18 months have made it more prudent to have at least six months of expenses in the bank.
This rule is simple, but not easy to follow. For most Australians, putting away six months’ worth of bill money is a big ask and actually represents a savings rate more than double the national average.
Expected net worth rule
This is a guide for estimating your future net worth based on your current income. The basic formula is 10 per cent (or 0.1) multiplied by your age and gross (pre-tax) annual income. It’s a very rough estimate but can be used to see if your investment strategies are going to get you where you want to be.
Rule of 110
This general investment rule estimates how much of your portfolio should be invested in the stock market. Subtract your age from 110 and that’s the percentage of your portfolio that should be in shares. So, for someone aged 60, 50 per cent of their portfolio should still be in shares.
The idea is that as stocks are a riskier investment option, younger people can afford to bear the risk as they have a longer time to recover. It’s a good rule to use if you are comfortable with the stock market but it doesn’t take into account an individual’s desire for risk or their ‘risk tolerance’.
If having a large portion of your money in shares would be a source of great stress in your life, then this rule may not be best for you.
20/4/10 vehicle rule
This rule relates to using finance to buy a vehicle. The basic rule states you should save a down payment of 20 per cent of the full on-road purchase price of the vehicle, the length of the loan should be no more than four years and total vehicle ownership costs should be no more than 10 per cent of annual income. Ownership costs include fuel, insurance and maintenance costs.
Do you know of other rules for financial success? Has following financial rules helped you get your finances where you want them? Let us know in the comments section below.
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Disclaimer: All content on YourLifeChoices website is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.