Sometimes it’s nice to have a simple estimate, a ballpark number, or a reasonable guess. In the financial world, people frequently use financial rules of thumb. The answers derived from applying these rules of thumb are meant to be approximations, not iron-clad certainties. Sometimes having a general idea is all you need to move forward.
What is a Rule of Thumb?
According to Wikipedia, a rule of thumb is “a principle with broad application that is not intended to be strictly accurate or reliable for every situation. It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination.” With this definition in mind, here are some financial rules of thumb.
Rule of 72
Want to know how long it will take to double your money? The growth of your money depends on the interest rate you get on that money. To find an approximation of how long it will take to double your money, divide the number 72 by the interest rate. If you are getting 6% interest on your money, it will take approximately 12 years to double your money (72 / 6 = 12). It works the same way if you know you want to double your money in a certain number of years, but you don’t how know much interest you need to make to do that. Divide the number of years into 72, and you’ll have your answer. For example, if you want to double your money in 10 years, divide 72 by 10 and you find that you will need to make a little over 7 percent interest to double your money in 10 years (72 / 10 = 7.2).
What is a Safe Withdrawal Rate in Retirement?
Want to know how much you can withdraw from your retirement savings and still have the money last for 30 years? One rule of thumb is that you can safely withdraw 4% of your balance each year (with an increase each year to account for inflation). For example, if you retire with a $500,000 nest egg, the rule suggests that you can safely withdraw $20,000 in the first year. In the second year, assuming 2% inflation, you could safely withdraw $20,400. Remember, these are rules of thumb for estimating purposes only.
How Much Do I Need to Save for Retirement?
If you save 15-20% of your gross salary, you are well on your way to a comfortable retirement. 15% to 20% can seem overwhelming in your early work years, when you are likely paying many bills at once, such as student loans, car payments, and mortgages. But if you keep 15-20% as a goal, and keep inching up your savings every year by even 1 percent, you will get there. Studies show that consistent, steady saving is the greatest predictor of financial success.
How Much Should I Borrow for College?
It’s tempting to borrow as much as you can to get through school. But most experts say not to burden yourself with more debt than the amount you can reasonably expect to make in salary the first year you graduate. So, if you are likely to be employed after graduation in a job that pays you $30,000, the rule of thumb is not to borrow more than $30,000 during your entire 4-year college career.
Andrea L. Blackwelder, CFP®, ChFC and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with Wisdom Wealth Strategies.