Financial Guidelines to Keep in Mind
Time is the most valuable commodity. Unfortunately, it is something that you can’t replace or buy more of. In today’s world it has become somewhat of a scarce resource with our incessant schedules and deadlines, and the expeditious pace our society has adopted. We have limited time for in-depth analysis of any kind when it comes to our personal lives, unless we are willing to sacrifice sleep (which many of us do already). This is where financial guidelines can be extremely helpful! Rules of thumb/guidelines are not precise and may not hold true 100 percent of the time, but they can serve as feasible benchmarks to build financial goals and plans around. Without a doubt, there are situations where precision and accuracy are not negotiable. However, there are times when an educated guess and/or rule of thumb figure will suffice as a starting point. From there, working with a certified financial planner will help you reach your end destination. Certified Financial Planners (CFP ®) know how to apply these guidelines to your specific situation and determine if changes should be made to ensure alignment with your primary goals and overall plan. Below are some common questions and respective guidelines:
How much should I have saved by now for retirement?
According to Fidelity, you should aim for:
1X your salary by age 30
3X your salary by age 40
6X your salary by age 50
8X your salary by age 60
10X your salary by age 67
These savings factors are based on the assumptions that a person saves 15% of their income annually beginning at age 25 (which includes any employer match), invests more than 50% on average of their savings in stocks over their lifetime, retires at age 67, and plans to maintain their preretirement lifestyle in retirement.
How much should I be saving for my emergency fund?
Many experts reference 3-6 months of monthly expenses as an acceptable amount. The size of your emergency fund will depend upon your specific lifestyle, expenses, income and dependents.
How much should I apply to retirement savings per month?
Obviously, someone just starting out may not be putting away as much as someone who has been in the workforce an extended period of time. A general rule of thumb is to apply 15% of your monthly income towards your retirement savings via a 401(k), 403(b) or IRA. If you are young and just starting out, try to put at least enough to get the company match, as this is free money. If you are over age 50, take advantage of catch-up contributions. For 2022, you can contribute $20,500 for the year if you are younger than 50, but if you are age 50 or older, you can contribute an additional $6,500 for a total of $27,000. You can contribute $6,000 to a traditional IRA or Roth IRA, but those age 50 and older can contribute an additional $1,000 for a total of $7,000/year.
How much should I have saved for my child’s education?
Fidelity suggests what is called the “College Savings 2K Rule.” It encourages parents to save $2,000 for each year of their child’s life. So, if you multiply your child’s age by $2,000, this is the amount you should have saved by now for their college education (this assumes a 4-year public college and that you only save 50% of the total cost for college).
Another financial guideline experts often give is the one-third rule. This rule recommends that families contribute one-third of the cost of college from savings, one-third from current income, and one-third from loans.
How much house can I afford to purchase?
Divide your monthly take home pay by 4. This is the amount of monthly mortgage payment you should strive not to exceed. Do not buy a home that costs more than 3X your annual salary. Keep housing expenses to no more than 25% of your income after taxes. Put down 20% as a down payment when purchasing your home to alleviate the extra cost of private mortgage insurance (PMI), which can run from 0.58 percent to 1.86 percent of the original amount of your loan, according to the Urban Institute. According to Freddie Mac, most borrowers will pay $30 to $70 per month in PMI premiums for every $100,000 borrowed. The amount you pay will depend upon your loan-to-value ratio and your credit score.
How much of a car payment can I afford?
Many apply the 20/4/10 rule where you put 20% down, finance no more than 4 years and don’t spend any more than 10% of your income on transportation costs. Typically, you want to spend less than 10% of your monthly take-home pay on your car payment, so you can keep your total car costs below 15% to 20% of your income.
How much life insurance coverage do I need?
One method is to add up your long-term financial obligations, such as mortgage payments or college fees, and then subtract your assets. The remainder is the gap that life insurance will have to fill. Another way to do a quick calculation is to multiply your income by 10. If you have kids, multiply by 10 but also add $100,000 per child for college expenses.
A third approach is to use the DIME method:
Debt: Add up your debts, other than your mortgage, plus an estimate of your funeral expenses.
Income: Decide for how many years your family would need support and multiply your annual income by that number.
Mortgage: Calculate the amount you need to pay off your mortgage.
Education: Estimate the cost of sending your kids to school and college. Add all these figures together to get a general idea of adequate coverage amount.
Should I rent or buy a house?
The Price to Rent ratio (P/R Ratio) is an excellent tool in helping to answer this question. The formula is as follows:
median home price / median annual rent = price-to-rent ratio
For example, take a $450,000 house for sale vs. a similar home for rent for $2,499/month ($29,988/year). Divide $450,000 by $29,988 and you get a P/R Ratio of 15.0. If the P.R ratio is over 15, the renting option may be the better choice.
How much of my money should go towards needs, wants and savings?
Elizabeth Warren and her daughter, Amelia Warren Tyagi, popularized the 50/20/30 rule. The rule allocates money into three separate buckets based on after-tax income (your take-home pay).
Mandatory expenses account for 50% of your income. This includes mortgage or rent payments, utilities, healthcare, basic groceries, transportation, and childcare costs.
Savings and debt payments account for 20% of your income. This means 20% of your take-home pay would go toward building an emergency fund, growing your retirement savings, or paying down credit card debt or student loans.
Wants account for 30% of your income. This includes nonessential costs that you could live without, such as dining, vacations, clothing, entertainment, etc.
For each category, divide the mandatory items’ total by the total take-home pay and then multiply by 100. This will give you the respective percentages.
How much student loan debt should I take on?
According to student loan expert Mark Kantrowitz, limit student loan debt to how much you expect to earn in your first year out of college. With this approach, Kantrowitz says, “if your total student loan debt at graduation is less than your annual starting salary, you should be able to repay your student loans in ten years or less.” It is reasonable to expect borrowers to spend half of the increase in average after-tax income from a college degree on repaying their student loans. This corresponds to having monthly loan payments that are about 10% of gross monthly income.
How much should I withdraw in retirement?
A common financial guideline many follow is the 4% rule. You add up all of your investments and withdraw 4% of that total during your first year of retirement. In the years that follow, you adjust that withdrawal amount to account for inflation. The rule holds that this will increase your chances of not outliving your money during a 30-year retirement. The 4% rule assumes you increase your spending every year by the rate of inflation and doesn’t account for portfolio performance or changes in spending. The rule applies to a portfolio that is invested 50% stocks and 50% bonds (many investor’s portfolio compositions may differ from this). This rule also uses historical market returns and there is no guarantee what the future may bring. The rule also does not include taxes or investment fees. Some in recent years have claimed this rule of thumb to not hold true. However, it was tested during some of the worst market downturns in history, including the Great Depression, so many consider it a viable guideline.
Again, these are all financial guidelines, not perfect science, or precise calculations. Understand the caveats prior to relying on them. They are merely starting points to employ. A certified financial planner can help you turn these estimates into more precise and accurate figures aligned specifically with your personal financial situation.
Please contact us at (410) 840-9200 if you’d like to discuss your specific situation.
The Balance. (November 2021). $2K Rule of Thumb. How Much to Save For Your Kids’ College.
Bankrate. (December 2021). What is PMI? Guide to How Private Mortgage Insurance Works.
Nerd Wallet. (February 2022). What Car Payment Can You Afford?
Nerd Wallet. (February 2022). How Much Life Insurance Do I Need?
The Balance. (March 2022). Using Price-to-Rent Ratio to Decide Between Buying and Renting.
Forbes. (March 2022). Your Guide to the 50/30/20 Budgeting Rule.
Forbes. (February 2022). How Much Student Loan Debt is Too Much?
Main Street Advisors, LLC. April 2022. Main Street Advisors, Inc. is a Registered Investment Advisor. The articles and opinions expressed in this material were gathered from a variety of sources, but are reviewed by Main Street Advisors, LLC, prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of April 2022 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual situation. Always contact your financial/investment professional before making any financial decisions. Main Street Advisors, LLC is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.