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Your Take: What Are Your Rules of Thumb?

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There are a lot of “rules of thumb” in the personal finance world. We all know the classic ones: you should save at least 10% of your income, you should have 6 – 12 months of expenses saved into an emergency fund, and you should X% of your portfolio invested in stocks where X is 120 minus your age. In fact, rules of thumb are so ubiquitous in personal finance that I took a look at four rules of thumb in need of some refreshing.

However, those are publicly known rules of thumb that experts have repeated over and over again. What I’d like to know is whether you have any personal rules of thumb that you live by? It doesn’t have to be strictly personal finance related, it just has to have served you well over the years.

I ask because in my post about the best car for students, Financial Samurai offered up a great rule:

I use the 1/10th rule we coined. Essentially, the car you buy should cost no more than 1/10th your gross income. I’ve used this rule to a T, and it works well.

I think that it might be a little on the low side, especially if you only have one income, but you wouldn’t be wrong to use a similar rule.

Do you have any personal rules of thumb that have worked well for you?

{ 27 comments, please add your thoughts now! }

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27 Responses to “Your Take: What Are Your Rules of Thumb?”

  1. Jimmyj says:

    I am in the midst of knocking off some debt. My method for paying on the debt is to round up to the nearest whole dollar over the minimum payment. For instance if the payment is $67.34, then I would send a check for $100.00. It works for me and I don’t even have to think about it. Just do it. I have paid off alot of debt this way. As long as you can fit the extra into your budget then it is a pretty sweet way to knock off your debt. I guess this is just my personal rule of thumb. It works especially well by rounding up to the nearest hundred dollar limit.

    Jimmyj

    • Jim says:

      That’s a simple yet effective way to decide how much more to pay down a debt, it’s a lot like how people save money by rounding up their spending to the nearest dollar. They spend $6, but they write down $10 in their “budget” and pocket the savings.

  2. Morning Jim – Thanks for the highlight! I figure, if the super wealthy who are earning millions a year aren’t spending no more than a several percentage of their gross income on cars, why should us common folk spend more and detonate our finances?

    There’s no such thing as a $1 million car, except for the Bugatti Veyron I guess, for some guy making $10 milliion a year to spend. He’ll probably be seen around in a Mercedes S550, Bentley, or Porsche instead… all of which are under $200,000, and less than 2% of his income. Obviously, this is an extreme example, but I’m just trying to highlight a point.

    Is it so bad for someone making $50,000 a year to drive a 2nd hand Honda Civic that costs $5,000? Not at all. I’m pround of my 9 year old, $6,500 beater (which I still think looks good :) ) I take up to Tahoe several times a year.

    I use the “1/10th rule” as a means to curb my unsatiable desire for new cars and as a motivating factor to try and make more money to justify my spending. Folks can read my ordeal of going through 8 cars in 10 years. At least I know how to really negotiate now!

    Another thing I always think about is the cost of an item PRE-TAX. A $200 iPod actually costs $300 in gross income (depending on your tax rate), which generally causes me to hesitate. I multiple anything I want to buy, by 1.5X, allowing me to really think whether I need/want the item.

    JimmyJ/Jim – You guys bring up a great rounding up and rounding down rule. I love it! I’ll definitely try and incorporate that in my thinking.

    Best, FS

  3. dilbert69 says:

    My wife and I earn about $230K. Our cars are probably worth around 1/10 that, but we paid a good deal more for them when they were newer. If you buy a car that’s worth only 1/10 of your gross income, pretty soon it will be worth less. I don’t have a car fetish, but I would say 1/5 to 1/4 is more realistic as long as you plan to keep it 10-12 years (assuming a mild climate).

  4. Traciatim says:

    I mostly agree with dilbert, I use the general rule of your house is 2 times your household income your total car budget is 1/4 your household income.

    This puts an 80000 income family in a 160K house with a total of 20K for cars (if they need 2, 10K a piece). This seems pretty reasonable to me.

    I just picked up an ’06 minivan for 9K with low miles on it, hopefully this will last us for at least until 2015. That would be nice.

    • dilbert69 says:

      Very few people in the Bay Area could find a suitable house for 2x their household income. Ours is worth about 3x.

      • I agree. We use the 30/30/3 rule (30% of gross cash flow goes to service the debt), 30% cash in the bank for the downpayment, and house equals to around 3X the value of your gross annual income).

        It all depends on your security and income outlook too. Bay Area is indeed tough to settle on just 2X annual gross. 3X-5X annual gross is more likely for most out here.

  5. nickel says:

    How about this… If it costs more money then you have, don’t buy it.

    • dilbert69 says:

      If I went with that, I’d be driving a much more expensive car, and my financial future would be in jeopardy.

    • Austin says:

      I second this rule of thumb. Unless it’s a house or an emergency I don’t see any reason to put yourself in debt with a purchase.

      I notice a lot of my peers get themselves into consumer debt because they don’t realize how much they’re actually paying in interest every month. Scary stuff, and my rule of thumb will hopefully keep me away from this.

  6. Wil says:

    My “rule of thumb” for investing has been to save at least have of any raise (from my regular job) for later. This started out as savings and soon became funding for my retirement plans. Over the years it really added up.

  7. NessaMae says:

    my rule of thumb is to not change my standard of living even as i get raises and promotions. i pay about the same right now for groceries, gas, car, rent. i know this is not the case for some but this has been a great way for me to save more without feeling like im missing out.

  8. zapeta says:

    A lot of good rules have already been mentioned, but one I use is to save 90% of any unexpected income/windfall. If you commit to saving 90% of even the smallest windfalls you can add a lot to your savings very quickly.

  9. Jim, thanks so much for asking this question. LOVE the way financial rules of thumb can help one break through “analysis paralysis” when making big decisions. The following are ones that I’ve found super helpful:

    * HOME: Keep the total purchase price of your home to 3x or less of your household income… and less is better (assuming 20% down, a 30-year fixed rate mortgage and normal interest rate environment, should keep your total all in housing costs to 30% or less of your gross income)

    * CAR: Keep total purchase price of all household automobiles to 30% or less of total household income (again,less is better). Should keep total all in transportation costs to 10% or less of your gross income (assuming 20% down, 5-year max loan period, and mid single interest rate)

    * EDUCATION: Don’t take on more in total debt than you think you will earn on average over your first 10 years out of school (logic: if you are devoting more than 10% of your gross income to student loan repayments for more than 10 years, you severely cramp your ability to save for other lifetime goals).

    * WEDDINGS: If you can’t pay for it in cash, don’t add it into your plans. You want to remember the day forever… but not because you are paying for it forever!

    * RETIREMENT: If you start saving in your 20s & 30s, 10% is a good number to target tucking away for your golden years… but for each additional decade that you delay add another 5% to that figure.

    • Martha says:

      I loved your “Rule of Thumb” about weddings! Many of our friends are getting married now and I feel that the pressure to spend so much puts many people into debt for one day. I used many “Bridal Bargains” to try and save many pennies during our big day.

    • Jill says:

      re: Education – I once read something that said your total student loans (undergrad+grad) should not be more than 1 year’s worth of salary.

  10. Greg says:

    Mortgage = 2X annual income. You can afford a house anywhere if you have enough of a down payment. It may not be a beautiful McMansion but it will be roof over your head.

    Car = Less than 20K for a known reliable brand/model IF you can pay cash. A rule of thumb that is in relation to income seems illogical. 1/4 or 1/10 either way, you could end up with car that only lasts 12 months or 12 years depending on what you purchased and how well you care for it.

    Savings = 20%+. (Unless you started in your early 20′s and you are already nearing retirement) The rest of us cannot depend on SS or enjoying a pension. You can’t retire on hope, if you don’t save for the golden years, nobody will do it for you.

    Emergency Fund = 6 months living expenses in an accessible account for routine challenges, 1K-$10K soundly secured if living in an area likely to have major natural disaster. (Thanks for the inspiration of a blog post for tonight!)

    Once all retirement/savings/emergency fund are funded and bills are paid, the only rule of thumb left for a desired purchase is… do you have the cash. If you can’t pay cash, you can’t afford it.

    • Andrew says:

      In a high cost of living area, you won’t be able to save a year’s income while renting to come up with that down payment. Also, I have lots of cash, but that doesn’t mean I can afford expensive things.

  11. daemondust says:

    Isn’t it a bit misleading to say ‘you need 6 months of your sallary’, but you aren’t going to continue to be saving while you’re living off your savings, so your expenses will be lower by the amount you save.

    • Andrew says:

      True. The rule of thumb I’ve always heard is six months of expenses. I would also assume that someone facing a loss of income would pare back expenses to the bone, so that what was previously six months of expenses might become seven or eight.

      • Jill says:

        Financial planners usually use X months (3,6,9, depending on the planner and client) of non-discretionary expenses – meaning if you would cut it out if you lost your job, you don’t have to count it for purposes of an emergency fund. We cut out savings, cable, clothing, etc

  12. I live in NYC and unfortunately a lot of the formulas and ratios just don’t work here. Thankfully our rent has stayed the same but we’ve increased our earning so now we are paying 30% of our take home pay on rent. I know many people who are paying 50%+!

  13. cliff s says:

    My rule of thumb is to never borrow to buy a depreciating asset. OK borrow for a home, college education, investment in a business, but not for a car, wedding, vacation, toys, and so on.

  14. Jill says:

    My rule of thumb is never to buy anything the first time I see it – I go home and wait to see if I still really want it. if I do, I look for it online and compare prices across multiple websites before purchasing

  15. Dave says:

    The only rule of thumbs I follow are spend less than you earn, and don’t buy a house if you think you will move within 5 years.

  16. Vic says:

    - Invest your raise
    - ‘Divide & conquer” I split my income between bank accounts & CD’s to make it less of a temptation to spend
    - Ask “is it a want or a need?” when buying something you are unsure about. Usually, the 10 second pause will result in putting it back on the shelf.
    - STOP EATING OUT. I usually bring snacks from home in bulk to keep me from hitting up the snack machine. i.e poptarts cost $1.00 in the vending machine vs the 38 cents I pay buying it in bulk at walmart.
    - Make saving a game.
    - Maximize the grace period of a credit card. I buy everything on credit and pay it off in full before the due date. My money sits in the bank earning interest while I use theirs for the time being for free


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