Dealing with your finances can be very tricky, because it is so very personal.
For today’s post, we thought we’d revisit some popular personal finance rules of thumb to see if any of them really add up.
Popular personal finance rules
Effective money management starts with watching where all your money goes and/or just staying out of prolonged debt.
Simple work can be very effective over time.
Thousands of personal finance books continue to harp on these subjects.
In a review of The Psychology of Money, on My Own Advsior, author Morgan Housel succinctly mentioned a key family rule his household lives by which we believe can be readily transferrable to any other household.
1. You don’t need to explain yourself to anyone else.
At the end of the day, you’re responsible for your own debt, line of credit, or other liabilities.
While both Joe and I personally believe it’s better to invest vs. pay down your mortgage when any investing rates of return are in your favour – we don’t know of anyone that loses sleep over being mortgage or debt-free.
“We own our house without a mortgage, which is the worst financial decision we’ve ever made but the best money decision we’ve ever made.” “On paper (paying off a mortgage with rates so low), it’s defenseless. But it works for us.”
2. Boring works wonders over time.
In Beat the Bank, author Larry Bates highlights you need to embrace “wealth builders” and avoid “wealth killers”.
Larry is a bit agnostic when it comes to paying down debt or investing. Just do one or both as much as you can.
“Everyone’s circumstances are different. I recognize some Canadians aren’t in a position to save, but I agree that 10% is a good savings target for most middle-income earners. Savings should be directed towards permanent debt reduction or investments. Either one will put Canadians in a much better financial position.”
In that spirit, we thought we’d highlight some popular personal finance rules that should add up to financial success over time – things our own members/clients have practiced themselves in their own way.
Popular personal finance rules
1. 50/30/20 Savings Rule
United States Senator Elizabeth Warren popularized her 50/30/20 budgeting rule in her book, All Your Worth: The Ultimate Lifetime Money Plan.
Essentially, the idea is to divide up your after-tax income and budget your finances into three categories:
- 50% for needs
- 30% for wants
- 20% for savings
While these percentages are just a guideline and therefore can be flexible, the power in this personal finance savings rule is you get into the habit of paying yourself first as a modest part of your after-tax income.
Key learning: the most successful members/clients we’ve interacted with on this site, have always had a long-term, multi-decade, sustained savings rate but they’ve admitted that savings rate fluctuates year over year. Their key to success was to save and keep saving regardless.
2. Retirement Rule of 25 / 4% safe withdrawal rate
The premise: take your anticipated annual retirement expenses (in future dollars, after tax) and multiply this amount by 25 for your “retirement number”.
Example: My Own Advisor in his recent Financial Independence Update figures he and his wife would need about $70,000 – $75,000 per year (after-tax) to enjoy the lifestyle they want in semi-retirement (assuming no debt).
Using the upper end of that range, that “retirement number” is a healthy sum (!) – the sum of their investments needs to be equivalent to $1,875,000 in today’s dollars!
Do they really need this much money?
We’ve posted on this site, a few times, including this pillar post that any 4% rules (while a decent starting point for retirement planning) should not be followed explicity.
In fact, it might be far too conservative…for any retiree at any age.
Depending on your time horizon, even if it is 30+ years, remember depending on stock returns…the 4% rule was founded on the worst case scenario: a withdrawal rate of closer to 4.15% and rounded down to 4%.
That withdrawal rate worked “in the worst historical market sequence…”.
Mapped forward in recent years by guru Michael Kitces, even if you retired on the eve of the GFC (Great Financial Crisis 2008-2009), thanks to 10-year+ bull market that followed the GFC you’d still be WAY ahead.
In fact, Michael and his team have done more work in recent years. They’ve replicated the Bengen study. In a whopping 50% of the time, using the 4% safe withdrawal rate you will finish not just WAY ahead but with almost X3 your wealth on top of a lifetime of spending using the 4% rule.
Reference: Check out the outstanding Michael Kitces study on the 4% withdrawal rule – that shows the extraordinary upside potential in sequence of return risk.
Key learning: the most successful members/clients we’ve interacted with on this site, ignore the 4% safe withdrawal rate. Instead, they have a bias to focus on total return when it comes to investing AND making reasonable estimates related to how much income their investment portfolio (amongst other income sources) can reasonably generate year after year.
Do any personal finance rules add up summary
Reading personal finance rules of thumb over the years remains interesting to us but they simply don’t account for any real-world experiences. Here are a few more that may make some sense and those that do not.
Rules of 10.
For big discretionary purchases – consider how that spending makes you feel and what value you might earn from major purchases in the hundreds or thousands of dollars: 10 days, 10 weeks or even 10 months into the future. This rule might provide the requisite time to pause and really consider if your spending aligns with your values.
When it comes to your car payment, limit payments to 10% of your take-home / after-tax income. This way, you have money leftover for other daily / household expenses. For the most part, we believe it’s OK to splurge on anything (even cars) as long as you can afford the payment and/or you could pay off the loan in short order, if needed. Life is for the living after all!
Finally, for decades, some experts have suggested a minimum of 10% savings rate for first, unexpected expenses (i.e., an emergency fund) and then saving for retirement after the emergency fund is intact. Sure, if you have no idea how much to save, this rule could provide another pay yourself first starting point but it doesn’t make sense for many depending on the circumstances. If you have a lower income or live in a very expensive area or are just starting out: then small loans, housing and groceries could cut into your rule immediately. Debt obligations should take priority. Should you have a higher income, and nearing retirement age, maybe you could save more to juice that retirement nest egg.
Based on our own experiences and more specifically those of our members/clients here at Cashflows & Portfolios, we are convinced that instead of following any personal finance rules above, the most successful folks we engage with leverage some personal finance rules of thumb to tailor their own wealth-building path. They use their financial literacy to customize their approach and adjust their methods over time. They are critical thinkers, planners, strategists, and risk managers. They learn what works, what doesn’t, and they apply those lessons over time to be better for it.
Do any personal finance rules add up?
100%, but only when they are tailored for you.
Need any support with your rules or math?
Knowing how to save and invest wisely but also move past things like the 4% rule are things we can help with – since such heuristics while interesting are just a sliver of the investment puzzle.
- Done-For-You – we do the work and data entry, and provide your reports OR
- DIY – whereby you do all the work, you do your own data entries, and you get your own results in some professional financial planning software – we essentially open up this solution for you to use 24/7 to be your own retirement income planner!
Just reach out if you wish to learn more!
We launched both services because we are passionate DIY investors who enjoy supporting and engaging with other DIY investors without the conflict of any advice.
If you are interested in learning more about both low-cost retirement projections services, read on and send us any questions anytime here.
Further Reading and Insights:
Some Canadians expect to need $1.7 million to retire with – we think that’s a major problem!
Thanks for your readership!
Mark and Joe.