As a general rule of thumb…
Always wait 30 minutes after eating before going in the water!
Make sure to change your oil every 3,000 miles!
Measure twice, cut once!
These are phrases you have probably heard throughout your life that have become second nature in guiding some of your decisions. In finance, rules of thumb can serve as helpful shortcuts to make quick decisions when you do not have the time, or simply do not feel up to doing the research. Let's have a look at some of the most common questions and their rules of thumb.
How should I set up a budget? Consider the 50/30/20 rule:
- Use 50% of your after-tax income on needs
- Use 30% of your after-tax income on wants
- Use 20% of your after-tax income for financial improvement (i.e. savings or debt reduction)
How much house should I buy?
- As the saying goes, "Just because you can, does not mean you should". In other words, just because you are approved at a certain level, does not mean it is financially prudent to overextend yourself
- Try to keep your mortgage payment at 25% of net pay or less
- Also consider contributing 1% of your home's current value into an account for future upkeep/maintenance
How much car should I buy? Consider the 20/10/4 rule:
- Make a down payment equal to at least 20% of the all-in cost
- Do not let the monthly payment cost more than 10% of your after-tax income
- Consider financing it for no longer than four years. If the math does not work, consider putting more down or a lower price point
- Plan to drive it double the years you finance it for
How much should I spend on wedding gift?
- How much you spend depends mainly on your budget and relationships with the couple
- For a coworker or a distant family friend/relative: $50-$75
- Relative or friend: $75-$100
- Close relative or close friend: $100-$150+
How much should I spend on an engagement ring?
- Consider shopping, or at least discussing, together instead of taking a blind guess
- Avoid purchasing during peak times like the time between Thanksgiving and Valentine's Day
- You do not have to follow De Beers suggestion of a multiple of the groom's monthly salary. Consider budget, debt, and future purchases that may arise
How much should I pay my child for an allowance?
- Consider starting this at an early age as a teaching tool for financial literacy. (Rich Dad Poor Dad by Robert Kiyosaki and Sharon Lechter is a great read for teenagers.)
- Make sure there is a clear line between tasks for an allowance and chores that are a responsibility
- Consider paying between 50 cents and $1 for every year of age per week. (i.e. If a child is 7, they would receive between $3.50 and $7/week)
While it could be a good idea to keep these in your back pocket, remember that they are not hard and fast rules. As Captain Barbosa would say, rules of thumb "are more what you'd call guidelines than actual rules." They are intended to steer you in the right direction, but it is still important to make sure due diligence is exercised for your specific circumstance. If you are ever unsure about what decision is best for you, a good rule of thumb is to check with your Private CFO®!