Do These Personal Finance “Rules” Still Hold Up?
Generic personal finance advice has always garnered some derision, but lately there’s been more of a backlash. The loudest voices have belonged to Millennials (those born after 1990), many of whom have struggled with their finances and now (understandably) bristle when told how much money they “should” have in investments (etc). So do the “rules of thumb” from yesteryear still apply to a younger generation trying to manage their money under very different realities? For that matter, are the old rules even relevant anymore?
It’s crucial to remember: This is personal finance. As always, the key word is personal. A rule of thumb exists because people love a good benchmark to compare themselves to, but falling short of the benchmark isn’t an indictment against your character. These rules of thumb can’t account for every unique situation you face; it’s simply a recommendation to the masses, without any nuance. With that said, let’s look at some of the most popular rules of thumb in personal finance, and consider whether they should still be used as guideposts in your financial plan.
Rule of Thumb 1: Have Two times your salary saved by age 35
It’s the rule of thumb heard around the world, or at least mercilessly mocked on Twitter by users who aren’t on track to save anywhere near that much – who cares about them really? Haters will be haters!
Traditional wisdom taught to Independent Financial Advisers in the Fundamentals of Financial Planning textbook maintains a 35 year old should have saved at least 1.6 times his or her salary. Which means if you, at 35, are earning (say) $60,000 per year, then you should have $96,000+ saved, and better still invested. Given that 60% of Millennials don’t have any money saved at all, even the textbook’s benchmark probably seems unrealistic to many people in their late 20s and early 30s.
Modern take: Plenty of millennials, Gen Xers, and even Baby Boomers scoff at the idea of having two times their salary saved by 35. Wage stagnation, student loan debt, and the gender wage gap are all commonly cited factors as to why this rule of thumb is no longer attainable for your average person. While it may feel laughably high, it’s still a decent benchmark if you have any desire to retire in your late 60s or early 70s. We’re living longer, the future of Social Security continues to be uncertain, and you never know if your health will allow you to continue working into your twilight years.
You could, however, set your sights on having a minimum of one times your salary saved by 35, especially for the traditionally employed; by using a Pension plan. For example, let’s say you started working at age 21, investing only 3% of your $30,000 (starting salary). That means you’re saving $900 a year. Factor in an increasing salary at (say) 5% per year, and with compound interest with an average return of 6% per annum, by age 28 you’ll have about $18,360, so well over half way there for such a small outlay (source: Royal London October 2018).
Rule of Thumb 2: Save at least 10% of your salary towards retirement
“10% just towards retirement?! You’ve got to be joking!” After all, you’re not just saving for retirement: You are also likely to have shorter-term saving goals too, like saving for a deposit on a home, a wedding, or even just your next holiday. Suffice to say, saving 10% just towards retirement means you have to save more than 10% of your salary so that you’re also working toward these other goals.
Saving more than 10% of your total take-home pay is definitely a stretch for many twenty-somethings. I was in a position to put away 10% of my salary towards retirement in my early twenties, but realised that I had to make sacrifices, as did most of my peers. However, I DID this because I knew no-one else was going to do it for me!
Modern take: Start small and build over time. Ideally, you should put enough aside, and then work up to larger contributions as your pay cheques get bigger. But if that feels unattainable, then begin by putting aside 1% of your salary towards retirement. It may seem like a pointless amount, but forming the habit is critical, whether you’re traditionally employed or self-employed.
Then, slowly increase that contribution by 1% every 6-12 months. You’ll probably barely notice a difference in your net pay, and you’ll slowly push towards the ideal 10% (by the age of 31).
Rule of Thumb 3: Have three to six months of living expenses in emergency savings
Emergencies will arise, so it’s important to be prepared. It’s perhaps even more critical for contractors, freelancers, or anyone else working with a variable income. Three months’ worth of expenses is a good start; six is ideal……………
When evaluating what constitutes three months of living expenses, note that it should be based on your bare-bones budget. Consider the amount you need to keep paying your rent or mortgage, have food on the table, pay the utilities and phone bill, cover transportation, and any other necessities such as student loans. Take all that, multiply it by three, and then make sure you’ve got at least that much saved in liquid assets should job loss or another financial emergency arise.
Modern take: The problem is that many young people already have their hands full paying off student loan debt, and trying to squirrel away three to six months of living expenses while paying off debt feels both impossible and impractical. You want your debt gone yesterday, so why would you put so much money towards building a savings buffer (for what might happen) instead of paying off debt that’s actively costing you interest?
To account for this, take the advice of personal finance guru Greg Pogonowski, and focus first on saving at least $1,000 for emergencies. $1,000 can often get you through smaller emergencies and prevents you from financing them on a credit card. However, that minimum emergency fund should be bumped up to $1,500 or even $2,000 if you have any dependents (both children and pets count – they have emergencies too!). Then, as you get a little more breathing room in your budget, add to your fund a little at a time until you get to that three-month mark.
Some rules of thumb you may want to consider and review? Let me know if you need MY help in forming a budget