Common Personal Finance Rules and What They Mean_Young woman sitting on her couch with her laptop

Common personal finance rules and what they mean

Many people have financial advice to share—often times a cliché—but how much of it is worth following? Let’s break down five common pieces of financial wisdom and figure out if they’re still relevant and realistic for most people.

1. Pay yourself first.

What does it mean?

The first thing you should do is route a portion of your money into your savings account. “Paying yourself” before allocating your funds to other parts of your budget is crucial because it helps you avoid deprioritizing your future or any unknowns. Ideally, you will be able to deposit your money into an interest-bearing account, such as a savings or money market account.

Is it still relevant?

Yes. Paying yourself first is generally a good idea. Building up your savings can protect you against unpredictable situations that could impact your finances, like a job loss or a car accident. However, it’s essential to determine how much you can afford to save. Determine how much money you can save by creating a budget. How much do you need to cover your monthly expenses? What is an essential expense vs. something that you could live without? Setting a budget and sticking to it can make a significant impact on your ability to contribute to an emergency fund or a savings goal.

2. Make a 20 percent down payment.

What does it mean?

Most people need to use a loan to make some major purchases like a car or a house. Most of the time, the lender requires you to pay for a portion of the item up front, which is called the down payment.

Is it still relevant?

It depends. The average down payment for new and used car purchases was 12 percent in 2017, and the average down payment for a home was 13 percent in 2018. Though the 20 percent down payment for a car or house was once regarded as the standard amount to pay up front, in many cases, this is no longer feasible or necessary for several buyers.

What if you can afford a 20 percent down payment? That’s great, with a 20 percent (or higher) down payment you can often secure better loan terms. If you’re like most people; however, you will need another option. Fortunately, there are many types of loans and programs that require a smaller down payment. In some cases, the 20 percent down payment can be a smart idea, but only if it fits into your budget. For some mortgage products, making a smaller down payment means you’ll have to pay for private mortgage insurance. Making a larger down payment can reduce the interest you’ll pay over time, and can make it easier for you to qualify for a car or home loan.

Young woman sitting on her couch with her laptop using a worksheet

3. Save 2X your salary by age 35.

What does it mean?

Some financial experts say that a good indication that you’re on track for a comfortable retirement is having twice your annual salary saved before your 36th birthday. So, if your salary is $40,000 at age 35, then you should have $80,000 saved.

Is it still relevant?

This is a relatively newer standard, and although achieving this accomplishment would undoubtedly benefit your retirement savings, it’s not a realistic goal for most people. In practice, you should save what you can afford and take advantage of additional opportunities to pad your nest egg. Here are a few savings-boosting opportunities to consider:

  • Utilize an employer-sponsored 401(k) with a match.
  • Put bonuses and unexpected windfalls into savings.
  • Make extra money through a second job, freelance work, or another side hustle.
  • Avoid paying interest by budgeting carefully and managing down debt.

Your financial situation is likely to change through your earning years, and with those fluctuations, your ability to save will change as well. The key to keeping on track is to always contribute something to savings and retirement. Contributions may feel insignificant when your income is low and retirement may not feel particularly relevant in your early years. However, if you’re saving early and often, you’ll be in a much better position to take advantage of the power of compounding interest.

4. Put 10 percent of your salary in your 401(k).

What does it mean?

When you sign up for an employer-sponsored 401(k), you can specify how much money goes into it with each paycheck. This can either be a flat amount or a percentage of your overall pay. It’s a typical recommendation that you put 10-15 percent of your salary into your 401(k) or other investment to build healthy retirement savings.

Is it still relevant?

Yes, this is still sound financial advice. The 10 percent rule should be thought of as a minimum and in time, you may want to bump up your 401(k) contribution even more. For instance, the 50/30/20 rule advises that you allocate 50% of your budget to needs, 30% to wants, and 20% to savings. Keep in mind, that your retirement savings should be different than your emergency savings account.

However, for the typical young professional, saving 10 percent in a 401(k) or another retirement account such as an IRA is a good starting point. For workers who are nearing retirement but don’t have much saved, dedicating a higher percentage could be essential.

If 10 percent seems like a lot, don’t feel pressured to start out with that allocation. It’s better to save any amount of money than none at all. So, begin with a percentage that you feel is sustainable for you. Budget around your retirement contributions. After some time, increase your allocation by 1 or 2 percent. If you earn a raise, find a higher paying position, or your overall bills decrease, consider adding the difference to your retirement savings rather than adjusting your spending habits. If you need help assessing just how much to put away for retirement, work with a Financial Advisor* to help get you on the right path.

5. Save three months’ worth of living expenses for emergencies.

What does it mean?

Some financial experts advise people to set aside three months’ worth of living expenses in a savings account for emergencies; some even go as far as 6-12 months. This is to help keep you financially stable should you lose your job or experience an injury that keeps you away from work.

Is it still relevant?

Yes, although the three-month threshold should be thought of as a minimum. If you lose a job or get seriously injured, you’ll need to continue paying for your monthly expenses such as rent or mortgage payments, groceries and utilities. If you have enough to cover the time between jobs or out of work, you won’t have to worry so much about your financial responsibilities so you can focus on your job hunt or recovery. It’s true that many do not have three months (or more) in savings for an emergency. For those who have far less in their emergency savings than they need, it can feel like an impossible task, but it all starts with taking the first step of setting a budget and saving what (and when) you can.

Achieving your savings goals starts with the right mindset. If you’re ready to start saving for the future, you’ll need a strategy.

 

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