With so many nuanced complexities of life, we often need a guiding light to show us which way to go to make wise decisions. Enter: rules of thumb. Specifically, personal finance rules of thumb.
We live fast-paced lives and often don’t have the time or capacity to invest in researching the best options for our money. When we face a decision—such as signing up for our 401(k) contribution—we quickly search for a simple solution and let our brains check out.
However, most rules for money don’t account for the unpredictable events and circumstances we face throughout our lives. Rather than rigidly following a set of rules, it’s more important to focus on building good financial habits and making informed decisions based on your individual circumstances.
Popular Rules for Money You Should Know (And When It’s Okay to Break Them)
We’re going to discuss common money rules, when it’s okay to break them, and the money principle or habit you should consider instead.
These are the four personal finance categories we’ll cover:
- Retirement
- Homeownership
- Savings
- Debt
Popular Retirement Rules
Retirement is difficult to conceptualize, especially when you’re deep in your career and can’t imagine what your golden years will look like. There are numerous retirement rules out there, it can be difficult to find what’s best for you among the noise.
Follow the 4% withdrawal rule for retirement. This rule has been around since the early 1990s and essentially means that you should withdraw 4% of your nest egg the first year of your retirement, and then 4% each consecutive year, adjusting for inflation. Following this rule will allow your portfolio to last for approximately 30 years (theoretically).
When to break it: This general rule of thumb can be a useful starting point but it does not factor in investment returns, unexpected expenses, long retirement periods, and market volatility. Rigidly following the 4% may create undue stress or cause you to run out of money.
Always max out your retirement plan. Contributing to a retirement account, such as a 401(k) or IRA, can be a key component of building long-term wealth.
When to break it: If you’re facing a financial hardship (such as from a job loss or unexpected medical expense), it’s okay to prioritize other financial goals over maxing out your retirement accounts.
Retirement principle to consider instead: Plan for your retirement as best you can with the information you have, keeping in mind the age you’d like to retire, your retirement account options (HSA, 401(k)s, pensions, etc.), your horizon timeline, and how much you already have saved. A financial advisor can help you see all your options and help you design your personalized retirement plan.
Popular Homeownership Rules
Put a 20% down payment on your home: This rule (which the majority of Americans don’t actually follow) will help you avoid paying private mortgage insurance (PMI), thus reducing your monthly mortgage payment.
When to break it: If you find a home that will serve your family well and you can reasonably afford the mortgage (including PMI), don’t get too caught up on this rigid rule. Saving 20% of the home’s value can be a daunting task, especially in areas with high housing costs.
Buy a home as soon as possible: Owning a home is a common financial goal, but it may not be the right choice for everyone.
When to break it: If you need or enjoy the flexibility that comes with renting, don’t feel pressured to buy a home (not everyone wants to spend their Saturday mowing the lawn and that’s okay). There are plenty of other investment options available that don’t require the time and maintenance that a house does.
Homeownership rule to live by: Responsibly buy a home when it makes sense for you. There are many factors at play when it comes to owning a home—your financial situation, lifestyle, school districts, and simply wanting to own a home so you can upgrade and design it how you like.
A Popular Savings Rule
Have three to six months’ worth of living expenses in an emergency fund. This common rule is meant to encourage people to have cash on hand to cover unexpected expenses.
When to break it: If you have a stable job with a secure income, you may be comfortable with a smaller emergency fund (and instead investing excess funds in liquid investments such as mutual funds or money market accounts).
On the other hand, if you have irregular income, work in a volatile industry, or are a one-income household with small children, you may need a larger emergency fund to provide a greater safety net.
Savings rule to live by: Adjust your savings rate and emergency fund amount as your family circumstances change. At the end of the day, you need to have the amount of money saved that allows you to sleep at night.
Popular Debt Rules
Pay off your debt as quickly as possible: This debt-free rule suggests paying off all debt, including student loans, credit card debt, and mortgages, as soon as possible.
When to break it: If you have low-interest debt, such as a mortgage or student loans, it may be more beneficial to prioritize other financial goals, such as investing or saving for retirement, instead of aggressively paying it off. Additionally, leveraging debt for investments, such as real estate or starting a business, can be a strategic financial move.
Avoid credit cards: Credit cards are convenient and can be a valuable tool for building credit and earning rewards.
When to break it: While avoiding credit cards may be the best choice for some people, others may benefit from using them strategically. If you pay off your balance in full each month, take advantage of rewards programs, and aren’t tempted to overspend, it’s perfectly acceptable to utilize credit cards.
Debt rule to live by: Be aware of the financial pitfalls that debt can bring to your life and utilize it responsibly. Always evaluate the interest rates, terms, and your overall financial picture before committing to debt.
Follow (And Break) The Rules with Legacy Planning
Financial rules of thumb are great for young people just starting—navigating through personal finance decisions is no easy feat! But when you’re ready to go beyond one-size-fits-all solutions, Legacy Planning is ready to help!
We’ll create a financial roadmap based on your unique financial situation, goals, risk tolerance, assets, liabilities, income, expenses, and more. This tailored approach focuses on your specific situation, rather than relying on general rules of thumb. Click here to schedule a conversation today!
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual.
