SYLVIANE NUCCIO

Financial rules of thumb are standards which may not be precise, but act as guidance when planning for various financial aspects of one’s life such as retirement and investment. They create a way or act as a starting point for those who have no idea how to go about these decisions.

Although these rules are convenient, they may not apply to everyone’s life or suit every economic cycle. You should not let them hold you back or be a strict basis for making financial decisions.

Here are some rules you should break depending on your situation.

1)  The 4% Withdrawal Rule

Retirees are often faced with the dilemma of how much they can withdraw from their retirement money without running out of funds.

Well, the 4% rule was set to answer this question with the assumption that the funds are mostly invested in stocks and bonds.

While it allows for a slight adjustment to inflation, the rule may not always work.

1. The market is always changing and the value of the portfolio may rise or fall depending on the market conditions. For this reason, 4% can be high for a portfolio that has been through unfavorable times risking untimely depletion of the portfolio balance.
2. For the rule to work, there must be consistency in the amount withdrawn every year. This rigidity does not factor in changes that may occur in the retiree’s needs. For instance, if one is in poor health, they may need to withdraw more than 4%.
3. Some portfolios contain a diversified portfolio besides stocks and bonds. High-risk investments are prone to significant changes in value. It could lead to a high balance which if withdrawn at the constant rate of 4%, could mean that the retiree will leave unused funds upon death.

The right guidance on the best rate of withdrawal from your retirement fund should come from an experienced investment manager.

By using algorithms to analyze the state of your portfolio and make predictions based on market performance, they can provide a rate that ensures that you do not run out funds prematurely or leave any hard-earned money unused.

2)  Asset Allocation Guided by Age

This rule offers guidance on investing. As you get older, most investment advisers recommend that you keep a less risky portfolio.

According to the rule, your age should act as a guide on how much you can invest in debt such as bonds. By subtracting it from 100, you can determine what percentage of the portfolio should go to equity such as stock.

For instance, if you are 30, 30% of your portfolio should comprise of debt while 70% should be equities. By applying this rule, as you age, your portfolio will also shift to low risk.

Here are some circumstances where you can forget this rule.

1. When you are risk tolerant, you can invest more in equity which is sure to bring in more returns than bonds. The rule is meant to protect the inexperienced from making losses in the stock market.
2. People have different lifestyles. Retirees who only have personal expenses to cover can survive on the low returns of a low-risk portfolio but others who have financial commitments such as educating children can benefit more from a higher high-return equity allocation.
3. You don’t have to play safe if you are knowledgeable about stock markets. Grow your portfolio as much as you can. With the average life expectancy increasing over the years, you can still have some time to recover from any loss in value.  

Allocating your assets should be based on your risk tolerance, experience with stock markets, and financial needs during retirement.

3)  The 10% Savings Rule

If you want to save for retirement but have no idea how to go about it, this rule of thumb recommends saving 10% of your income.

Although it’s a good starting point for young people who want to build a retirement fund early, it may be too little for those who start saving a little later in life.

The 10% rule may not apply to everyone for a number of reasons.

1. Some people have more retirement needs than others. A retiree who has dependents, for instance, may need more money to cover the expenses and will thus need to save more. 
2. Like mentioned earlier, lifestyles differ, and a one-size-fits-all cannot apply. While one person may prefer to move to the countryside and lead a quiet and peaceful retirement, another may prefer to travel and enjoy the finer things in life and will require more funds.
3. People have different financial situations. If you are in pensionable employment, have income-generating assets such as real estate, and a stable portfolio, you can comfortably cut back on the 10%. But someone relying solely on the retirement savings may need to save more.

Technology has made everything easier, including securing your future. If a financial planner is expensive, use retirement savings calculators to know how much you should save based on your financial position.

4)  50/30/20 budget rule

Senator Elizabeth Warren introduced the 50/30/20 budget rule and it has been used by many income-earners as a guide for financial planning.

How does it work?

The rule states that you should use 50% of your after-tax income on needs such as food housing, utilities and minimum debt repayments, 30% on wants such as new clothes and vacations, and 20% on savings, investments and debt repayment.

You must have noticed that debt repayment appears twice. This is because your minimum debt repayment is a need, and if not met, it can destroy your credit score. However, there are many ways possible to repair your credit score by taking bad credit loans with realistic loans.  Any extra money you pay above the minimum amount should fall in the 20% category.

Although this is a very good guide for budgeting, you may have to break it in either of the following situations.

1. When the cost of living in your town has you spending more than 50% on needs. In this case, leave 20% untouched, but adjust wants to cover for the extra used on needs.
2. If you are a low income-earner, using 20% on savings and debts may leave you with insufficient money to survive on.
3. If you have high-value financial goals such as investing in real estate, you may need to invest and save more than 20%.

Use the concept behind the 50/30/20 budget rule to draw a budget that fits your income, liabilities, and expenses. It should also make achieving your financial goals easier.

5)  Spending 30% on Housing

With housing being a significant part of every household’s budget, using 30% for this expense ensures you are not overburdened. Housing expenses include rent and the associated utilities for renters, and mortgage interest, taxes, and maintenance costs for homeowners.

This does not always work.

1. A 30% housing budget may be too low for people living in expensive towns.
2. For large families, limiting the housing budget to 30% means they might have to squeeze in a small house or live in a cheap neighborhood that in most cases is unsafe.
3. The percentage is based on gross income. It fails to consider deductions such as retirement contributions, health insurance, and tax which could largely reduce the income.

Get a mortgage plan or rent a house that meets your personal needs without financially straining you.

6)  The 6-Months Emergency Fund Rule

You have probably seen or heard of the 6-months emergency savings rule in almost every financial management article, book, or podcast. It states that you should have money equating six months’ worth of living expenses in a savings account to be used during emergencies.

Having an emergency fund is vital, but does it have to be 6 months savings. Here are a few things you should keep in mind when building your emergency savings.

1. What are you comfortable with? Would you rather have ten months’ worth of savings? If your company is known to frequently lay people off, more savings are better.
2. Do you have dependents? If there are siblings depending on you to pay their fees or have a sick spouse or parent, you might need more savings to cover these expenses in case of lose of income.
3. What kind of emergency situations are you prone to? Although this may be hard to predict, you can tell depending on family history or patterns. For instance, if there are genetic illnesses in your family, try to save more. If there is a low season in your business such as the agricultural industry, save with this in mind.

Six months is just a starting point, your savings should depend on your individual needs, lifestyle, source of income, and comfort level.

If there is one financial rule that does not change, is the need for proper money management.

Any other thumb of the rule with regards to spending, budgeting, savings, retirement, and investments is great when acting as a guide, but your decision should be based on your individual needs, goals, and financial status.