Financial Rules of Thumb

Rules of thumb can be useful guides in financial planning, but individual financial circumstances demand individual answers. Here are a few “rules” that can provide useful starting points, and should be considered only in light of your individual circumstances.

Savings
Save 10 percent of your income! As a rule of thumb, this is not a bad one. The average American saves a lot less - around four to five percent. If you have steadily saved 10 percent all your working life and invested it wisely for a healthy return over the years, 10 percent might serve you well.

There is no question that saving money is a habit - and the best habits are learned while young. That is why it is so critical that children and young adults adopt good spending and saving habits.

But if you’re entering middle age or later with a spotty savings record, or you’ve not been aggressive in your investing, you probably will need to bump the rate up to 15 or 20 percent - or possibly more - in order to save enough money to see you through a comfortable retirement.

Pre-retirement Income
Retirees need 70 percent of their pre-retirement income to live on! People not only live longer today; they are more active, requiring more money. Expenses such as housing and taxes may decrease during retirement, but travel and medical expenses may go up. Some Financial professionals advise shooting for 90 percent of your pre-retirement income.

Emergency Savings
Set aside six months of living expenses in emergency savings! It is important to have an emergency fund of readily accessible cash to see you through a temporary loss of income or to cover an insurance deductible or other unusual expenses. However, six months is an arbitrary rule.

If both you and your spouse work in stable jobs with stable income, three months may be sufficient. If you work in an unstable job or unstable industry, or your income fluctuates because you are a commissioned salesperson or a self-employed consultant, for example, six months may not be enough.

Life Insurance
You need six times (or four or ten times) your annual income in life insurance! The numbers for this rule are all over the map. None of them may fit your needs. Two people may have identical annual incomes, but if one has three school-age kids and a spouse who does not work, while the other person has no children, is not married, and has considerable assets, then their life insurance needs are quite different.

Have a needs analysis prepared and re-evaluate your life and disability insurance program at least every three years.

Investing in Stock
One hundred minus your age is the percentage of your investments that should be in stocks! Again, it is not a bad guide in that many people do not have enough of their investments in long-term, higher-earning assets that will keep them ahead of inflation and taxes.

People retiring often get completely out of stocks when they should be leaving some in to see them through 20 or more years of retirement. However, investments are too important to leave up to a rule of thumb. Consult with your investment advisor.

Refinancing Your Home
Refinance only if the new rate is two percentage points less than your old one! Sometimes it is worth refinancing if the spread is only one percent, and sometimes a spread of two percent is not enough.

The decision of whether to refinance will depend on such factors as how long you intend to live in the house, the cost of refinancing, your tax bracket, what you do with the money you save each month by refinancing, and the number of years on the loan.