Every single day we are faced with financial decisions. From deciding if you should buy a Dunkin donut’s iced coffee to choosing how much you should allocate for retirement, the level of thought put into these decisions can vary greatly. Some of these decisions can be quite simple but others require careful thought and consideration. These 7 personal finance rules of thumb will help you critically think through some of these harder financial decisions.
The Rule of 72
The rule of 72 is used to estimate how long it will take to double your investment by dividing 72 by the fixed interest rate. For example, based on the rule of 72 if you invest $1,000 into something with a fixed interest rate of 10% then 72 / 10% = 7.2 years. That means it will take you approximately 7.2 years to double your investment from $1,000 to $2,000.
This is a great tool to use to quickly calculate how long it will take to double your investment. However, you must remember that this is an approximation and is only applicable for fixed rate investments.
1% Rule
This rule is specific to real estate investing and is meant to be a guideline for investment property purchases. The 1% rule is followed by many investors as a general guideline to determine a good deal from a bad deal.
The 1% rule states that the monthly income from a property should amount to 1% of the total purchase price. For example if you were looking to purchase a duplex for $100,000 then the monthly rental income would have to be $1,000 in order to meet the criteria of the 1% rule. If the total rents are less than $1,000 then you should probably walk away. If they are greater than $1,000 then this property is worth looking further into.
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50/30/20 Rule
This rule is more of a guideline than a rule and is primarily meant for people starting their first budget. The rule states that 50% of your after tax income should be spent on your needs, 30% on your wants, and 20% on your savings.
The 50/30/20 rule is by no means the perfect budget but it is a great starting point. The key with this budget is being able to identify what is a want and what is a need. Often times, certain luxuries such as eating out can be perceived as a need but in reality it’s a want.
If your interested in crushing your budget check out this article from Gina, How I Budget to Save 65% of My Income.
3-6 Months of an Emergency Fund
An emergency fund is an account that is strictly for emergencies only and should not be used for anything else. Financial planners recommend to establish an emergency fund of 3-6 months worth of expenses.
You never know when an emergency is going to happen, so it’s important to prepare financially for these cases. Did you know according to CNN, 40% of Americans can’t cover a $400 emergency expense? Don’t be part of this 40%, budget effectively and contribute to your emergency fund.
For more information on emergency funds read, Why You Need An Emergency Fund.
High Interest Debt
When deciding which debt should be paid off first you should prioritize the high interest debt. The debt with the the highest interest rate should be paid off first and so on. Typically, credit card debt carries the highest interest rates (around 20%) and therefore should be paid off first. If possible, refinancing and then paying off the debt is also a great option.
You want to pay off these accounts first because they will increase your overall debt the fastest. For example, if you have credit card debt of $1,000 at 20% monthly interest then your overall debt will increase to $1,200 if you don’t make a payment. The accounts with smaller interest rates will increase your debt at a slower rate.
If you want to learn How to Take Control of Your Credit Card Debt tap here.
Avoid Lifestyle Inflation
First off, to be clear lifestyle inflation is when you start spending frivolously because you think you can afford to. Unfortunately, this is a trap that so many of us fall into. Keeping up with the Joneses is NOT worth it! Instead, find the level of spending that you are comfortable living at. When you receive a raise or a bonus put that money towards savings or investing instead of spending it.
Avoiding lifestyle inflation will allow you to put more towards savings and allow you to retire earlier. Just because your friend Jon bought a brand new BMW doesn’t mean you should too. Focus on your financial goals and avoid making unnecessary purchases.
Click here to learn How to Avoid Lifestyle Inflation.
20/4/10 Rule
Gina and I are strongly against buying brand new cars or really expensive used cars simply because they are depreciating assets. However, we understand that everyone has different tastes and a new vehicle may bring them happiness.
If you are thinking about buying a new car you should consider following the 20/4/10 rule. This rule says that you should spend at least 20% on the down payment, finance the car for no more than 4 years, and not let your monthly vehicle expenses exceed 10% of your gross income.
This rule will help you find a vehicle that is affordable and will ensure that you will have it paid off in 4 years. Again we don’t recommend buying a brand new car. However, ff you do then this is a solid rule to follow.
Closing Thoughts
These 7 best personal finance rules of thumb will assist you with your investment strategy, debt repayment strategy, and budgeting strategy. If you’ve ever used any of these rules let us know your experience in the comment section. If you have any other financial rules of thumb that we left out please share those as well. 🙂
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