Financial Rules of Thumb as a General Guide

I love to spend time outdoors. This summer my family and I were fortunate to spend some time in Yosemite and Mammoth enjoying the beauty of God’s creation. In planning these trips the vast resources available to make sure we were able to do all the things we wanted to do and maximize our time were extremely valuable. As you can imagine, one of the main tools we used on our trip was a GPS to help get us where we were going using the most efficient route. A GPS provides specific instructions based on the exact information you plug into it. When hiking, one of the essential items you should always have is a navigational tool. A GPS works great, however if it dies, or you don’t have a signal it won’t be much help, and in that case, an old-fashioned compass can provide a general sense of direction and guidance.

In the area of personal finance there are many rules-of-thumb that can serve the function of a “compass” in providing a general sense of direction. When evaluating whether you’re on track financially, rules-of-thumb can be a starting point and help identify significant discrepancies. Keep in mind that the best solution for you in any of the areas listed below may vary significantly from the “rule”. Factors such as age, income, lifestyle, tax bracket, family, stage of life, career, personal preference, and many others may lead to a recommended path that wouldn’t be found very easily using a compass.

Below are some common financial planning rules-of-thumb and a few considerations that could impact each “rule”.

Cash Savings:  Keep 3 to 6 months of expenses as an emergency cash fund

Considerations: Stability of your income, one or two income family, upcoming planned expenses, other savings available, your peace of mind

Life Insurance: Have 8-10 times your annual income in coverage

Considerations: Age, dependence, future income and lifestyle (ex. buying a bigger home or having kids), savings and other assets, stage of life (ex. retired)

Retirement Savings: Save 10-15% of your income into retirement accounts

Considerations: Current retirement savings, how your money is invested (more conservatively or growth oriented), when you plan to retire, your future income needs and sources of income, if your home will be paid off in retirement

Asset Allocation: 110 minus your age is how much you should allocate towards stocks (ex. if you’re 40 you would hold 70% in stocks)

Considerations: Your risk/return objectives, your current investments, if you’re contributing or taking income from the investment

Retirement Checkpoints: Save 0.5-1X income by age 30, 2-3X by age 40, 4-5X by age 50, 6-8X by age 60

Considerations: Retirement age, lifestyle, investment strategy, income sources in retirement, types of investments owned (ex. IRA, Roth IRA, taxable), future income changes, expenses and goals in retirement

4% Rule – In the first year of your retirement you can take up to 4% of your portfolio value and increase that annually for inflation (ex. $1M initially is $40,000 in year one)

Considerations: Your asset allocation, other income sources (current and future), life expectancy, your risk tolerance, market conditions, ongoing portfolio changes/adjustments

These rules-of-thumb can be used as a starting point to provide a frame of reference. Though these rules are better than following nothing at all, they are far from providing assurance that you are on track to reach your specific financial objectives.

For many people, doing the best they can as they are busy with family and careers, and following general rules-of-thumb is a good start point. However, if retirement feels like it’s fast approaching or you’d like to get a more accurate GPS reading, feel free to contact me.