Personal financial rules of thumb can be helpful as a way to get a handle on where to begin or what general target numbers or percentages might be useful to know about.
Sorry for 3 cliches in 1 sentence, but: these “rules of thumb” should be taken with a “grain of salt” because most “rules are meant to be broken.”
These are just general guidelines, which should be taken along with other factors unique to your own personal financial situation.
1. What percent of gross income to save for retirement?
A reasonable target to aim for is 10-20% of your gross income, after you have paid off all of your (high-interest) non-mortgage debt and after you’ve set up an emergency fund of at least 6-9+ months of expenses. This percentage includes the amount you are saving through your 401(k) (including any company match) as well as any other retirement accounts.
If you’re just starting to save for retirement, you may find 10-20% to be too high for you to manage. You can start smaller and increase incrementally over time. Starting with any amount (1-3%) is much better than not saving for retirement at all. Starting with even a small percentage gets you into the habit of saving for retirement.
Some people (including those who follow the “FIRE movement”—Financial Independence Retire Early) find ways to save 25%, 50%, or even much more of their gross income and have been able to retire early or achieve financial independence much earlier than they otherwise would have been able to do.
2. How much to put aside in an emergency fund?
A reasonable target amount is 6-9+ months of expenses, but your specific situation may require a larger or smaller amount. Factors to consider include:
- What industry are you in and how long would it typically take for you to get another job if you lost or quit a job?
- What stage in your career are you in and what income level are you looking to replace? (Higher incomes may be harder or take longer to replace than more junior salaries.)
- Are you the only one earning a salary in your family?
- If the income interruption were health-based, do you have good health and disability insurance? How long could you afford to pay your monthly bills while you are unable to work?
In an ideal world, you should pay off all of your credit-card debt before you establish an emergency fund. However, you should consider setting aside some money in an emergency fund for the bare essentials, even though you may be carrying some (hopefully small amount of) credit-card debt.
3. How much to spend on buying a house or apartment?
Under the 28/36 Rule, a mortgage lender will typically offer you a mortgage in which the total monthly PITI (Principal, Interest, Taxes, and Insurance, plus any homeowner association fees in a condo) is less than or equal to 28% of your monthly gross income, and the total monthly PITI plus all your other monthly debt payments are less than or equal to 36% of your monthly gross income. The 28/36 Rule for mortgage qualification is covered in more detail in our Mortgages section.
Just because a mortgage lender is willing to lend you a certain amount, don’t assume that this is the correct number for you. Figure out how your payments of PITI will fit into your overall budget in your new home, including all the other expenses associated with owning a home. Don’t let yourself become “house poor.” Use the 28/36 Rule to do some rough calculations, but figure out your own budget that works best for you.
Remember to include other hidden expenses such as renovation (is the house or apartment a fixer-upper or in move-in condition?), moving expenses, closing costs (including any points), new furniture, etc.
4. How much to spend on rent?
According to U.S. HUD (Department of Housing and Urban Development) guidelines, a family that spends more than 30% of its gross income on housing is considered “cost burdened.”
According to The New York Times, landlords in NYC also follow this 30% guideline by requiring that tenants’ annual gross income at least equal 40 times the monthly rent. (40=12 months/30%)
Spending no more than 30% of gross income on housing (i.e., earning annually at least 40 times the monthly rent) is a reasonable upper limit. Spending more than that would put a large burden on your budget and make your finances extremely tight for saving and other expenses. Spending less than that will give you more breathing room to save for other goals.
Under these guidelines, a person earning $50,000/year should spend no more than $1,250/month in rent:
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- $1,250 x 40 = $50,000
- ($50,000 x 30%)/12 mos = $1,250
To help make housing in many large cities more affordable, consider living with a roommate to share the cost. This also helps with splitting flat costs like cable and Internet, as well as splitting who buys (and owns) the common area TV or the couch.
5. How much to spend on buying a car?
Some people use the 20/4/10 Rule for car buying, in which you make a downpayment of at least 20% in cash, take out a loan for no more than 4 years, and spend no more 10% of your monthly gross income on your car payment (including principal, interest, and insurance).
Under this rule, a person earning $50,000/year could afford car payments of $417 for 4 years, with 20% down, and a person earning $100,000/year could afford car payments of $834 for 4 years with 20% down. That sounds like a lot of money, especially since it doesn’t include gas, car maintenance, car insurance, and possibly parking fees (for some apartment buildings or commuter lots).
According to the most recent U.S. Bureau of Labor Statistics for 2016, the annual average expenditure on vehicle purchases was 4.9% of gross income, roughly half of the 10% figure above.
We think 5% of monthly gross income is a more realistic monthly payment target (as an upper limit), especially for younger people just starting out. Given the high cost of new cars, we think it makes sense to at least consider a reliable, dealer-certified used car that has been independently inspected by a mechanic of your own choosing (or maybe even two). Alternatively, buying a reasonably priced new car for cash (or mostly cash) and holding onto it for a longer period of time (if you maintain it well) can also make sense for some people.
Some lenders will offer car loans up to 8 years. We think that’s too long a term. A 4-year term seems more reasonable. With a 4-year loan term, you will hopefully have a number of years of payment-free car ownership after the note is fully paid off.
6. How much to spend on an engagement ring?
It truly is the thought that counts, not the price tag. The act of giving someone an engagement ring represents a symbol of your love and commitment, and no price tag should ever add to or take away from that sincere sentiment. Now that we’ve gotten the mushiness out of the way, how much should you think about spending on a ring?
First, in Otterwize’s view, you should never pay for an engagement ring with a credit card if you can’t afford to pay the bill in full at the end of the month. The same is true for buying with any type of loan or store financing. If you can’t afford the ring in full, don’t buy it. There are lots of lenders that would “love” to finance this ring for you. Save “I Do” for the marriage, but say “I Don’t” to the financing.
An alternative is to buy a much simpler ring (and maybe get the one you want at a later anniversary/commitment ceremony, etc.) or try some other symbolic gesture altogether. (Where’s it written that there has to be a ring?)
Second, there are beautiful rings and other pieces of jewelry in every price point. Don’t let any salesperson or anyone else influence you to spend more than you can comfortably afford.
Depending upon your salary and financial situation, you might consider as a general guideline a maximum of one month’s salary (before tax), as long as the amount you select fits comfortably within your budget and other obligations, and won’t disrupt your savings. This is just a suggestion, and only you can know the right number for your own financial situation. For many people (and many different salary levels), one month’s salary is much too high. You have to assess your own values, priorities, and financial matters, and decide this for yourself. This is a highly personal matter with a lot of moving parts.
We’ve seen different rules of thumb (or ring finger) on this issue, reaching as high as three months of gross salary. In our view, spending up to 3 months of salary seems unrealistic and quite high, especially these days with heavier student debt burdens and people getting married at a later age (earning a higher salary). Again, you need to consider your own budget and your own financial picture.
- Don’t ever spend more than you can comfortably afford.
- When deciding on a budget, remember to include the possible extra cost of insurance (year after year), if you decide not to self-insure.
- If your salary is on the higher end, the one month rule may result in a number that is higher than you might need or want to spend anyway. Don’t be tied to any formula.
- None of these rules can be applied in a vacuum. You need to look at your own financial situation and decide for yourself what you want to spend. That number may be higher or lower than any guideline may suggest.
- Do some comparison shopping, get educated about the things to look for in a ring (if you’re looking at a diamond, do some research on the 4 C’s : cut, clarity, carat, and color), and decide how much you can realistically afford to spend as well as how much you want to spend. Keep that number in mind at the store and don’t be tempted by a heavy sales pitch to go over your own budget.
7. What percent of your monthly budget should be spent on food?
This answer is dependent upon many factors, including the size of your family, your location (cost of food varies based on geography), income, other needs, etc. Personal finance expert Dave Ramsey recommends spending 10-15% of your take-home pay on food. This includes both grocery purchases and eating out in restaurants. According to the most recent Bureau of Labor Statistics from 2017, the average percentage of annual expenditures spent on food by single, married, and married with children households ranged from 12.0-13.6%.
A range of 10-15% of the monthly budget spent on food sounds reasonable, subject to household size and other needs unique to your situation. Eating in restaurants, ordering in take-out meals, or buying prepared foods will of course significantly increase the amount you spend on food, so try to limit those splurges, even though it may be more convenient to have food prepared for you.
Otterwize has a section called “SimmeringSavings” devoted to cost-conscious recipes. Turn your savings into potential earnings by investing the cost difference.
Figuring out how much you spend on food can be tedious. Check out our Savings Apps page to help streamline the process.
8. How should your monthly budget be divided up among needs, wants, and savings?
Consider using the 50/30/20 Rule:
- 50% of after-tax income for necessities (food, housing, insurance, transportation, basic clothing, etc.)
- 30% of after-tax income for discretionary spending (restaurants, vacations, other clothing, gym memberships, entertainment, etc.)
- 20% of after-tax income for savings, debt repayment, and investment.
The 50/30/20 Rule is of course just a guideline. One of the benefits of analyzing your budget using a 50/30/20 allocation is being able to measure your expenditures against a benchmark so that you can identify focus areas to cut spending.
A true 50/30/20 split may be hard to achieve, especially if you are just starting out, live in a city with very high housing costs, have a large student-loan balance, or support a family on one income. However, that just means this is something to reach toward.
9. How much will you need to maintain your standard of living in retirement?
This question depends upon a lot of factors, many of which you can’t always predict, including:
- where and when you plan to retire
- anticipated spending needs, including how you think you would want to spend your retirement years (traveling and other high-cost plans vs. downsizing or living a more frugal lifestyle)
- health considerations
- inflation
- social security benefits
- your asset allocation
- your future housing situation (e.g., will your home be fully paid off? Will you downsize your housing?)
- market conditions at the time you retire (and even for the next 10 years or so, which is an unknown you cannot predict or control)
As a very rough rule of thumb, some experts say that you should have in retirement savings AT LEAST 25 to 30 times your anticipated annual spending. This figure would be dependent upon many factors, including those mentioned above.
- As an example, if you expected to spend $5,000/month ($60,000/year) in retirement, this rule of thumb would suggest you would need a nest egg of between $1.5 and $1.8 million.
A more fine-tuned approach would suggest an even higher amount in many cases. (See, for example, the discussion of safe withdrawal rates and the need to take into account market conditions at the time of retirement and the first ten years afterwards.)
This is a critically important question and one that cannot readily be addressed in a simplistic one-size-fits-all rule. A prudent approach would be to consult with a financial advisor to come up with a realistic figure for your particular situation.
10. How much credit-card debt is too much?
Trick question. Any amount is too much. You should try to pay off all your credit-card debt as soon as you can.
The only exception would be:
- extreme cases of financial need, such as unexpected medical expenses; and
- if your income is seasonal or cyclical and you are certain (keyword, but hard to achieve in the real world) that you will be receiving income at a not-too-distant future date. Even in the case of seasonal bonuses, commissions, deferred income, etc., credit-card debt should be limited to only those items that are absolute necessities. Employers can still go under before you are paid what you are owed.
Here’s an extra rule of thumb, just because:
11. How to make ‘Rule of Thumb’ plural?
Just like mothers-in-law, fathers-in-law, attorneys general, editors-in-chief, maids-of-honor, passers-by, and lots of other odd-sounding-but-correct plural forms of words, the plural of “rule of thumb” is “rules of thumb.” “Rule of thumbs” is not correct, because this is about multiple rules, not multiple thumbs.
