Finances have always been a hot topic. Everyone wants a great financial future, and there has never been a shortage of blogs, articles, videos, and social media posts spouting financial advice for the masses.
But apparently, we still perform poorly when it comes to our finances in real life.
Did you know that:
- 19 percent of Americans report spending more than their income in the past year.
- 38 percent of adults have less than $1,000 saved for financial emergencies.
- Only 24 percent of millennials demonstrate the ability to understand basic financial concepts.
- About 4 in 7 Americans are financially illiterate and unable to manage their finances.
- The official poverty rate in 2020 was 11.4 percent, up 1% from 2019.
So what’s the problem? Are we lazy? Are we dumb? I doubt it. It could just be that there’s too much advice out there, some of them seemingly contradictory.
In this post, we’ve put together finance rules that we think are truly beneficial for anyone to implement into their lives.
Let’s get right into it.
1. The 4% retirement rule
The 4% rule is a guideline used to determine the safe amount of funds that can be withdrawn from a retirement account every year.
This is based on the premise that you do not want to run out of money during retirement despite the fact that you still need to withdraw funds regularly to live off.
The rule states that you can withdraw 4% of your portfolio each year in retirement and have a high probability of never running out of money for the entirety of your life.
It doesn’t matter if you retire traditionally at 65 and expect 30 more years of life, or if you’re an early retiree and expecting 70 more years of life.
This withdrawal rate is considered to be a safe withdrawal rate (or SWR for short) by experts as it theoretically allows for an infinite number of 4% withdrawals once a year without exhausting your portfolio.
For example, if you had a $1 million portfolio, you could withdraw $40,000 each and every year of your remaining life and never run out of money, statistically.
Example of the 4% rule
Suppose you’re able to keep your withdrawals at a steady 4% (or less) each year.
And suppose you have $1 million dollars in your portfolio at the time of your retirement.
For the first year, you take out $40,000 as allowed by the 4% rule. For those that like to see the math:
- $1,000,000 x (4/100) = $40,000
You then use that to pay for the cost of living for the year.
You’re left with $960,000 in your account for the year.
Now suppose the stock and bond markets give you a combined 5% return by the end of the year, and that’s a pretty conservative assumption given present-day economic conditions.
- $960,000 x (5/100) = $48,000
That $48,000 (in the form of capital gains, dividends, and yield) added to $960,000 gives you a grand total of $1,008,000 to start off the following year with.
Despite having spent money to live for the year, you are even better off the following year. How cool is that!
You can imagine by rinsing and repeating that for any number of years, you’d do quite well.
However, life doesn’t always go up, and neither do stocks or bonds. So the best assumption this rule can make is that on average, the stock market will return more than the 4% we’ve spent for each year.
As long as the stock market doesn’t tank significantly in the first few years of retirement, statistically, it’ll work out for you.
2. The 1% spending rule
While shopping, it can be easy to let your desires govern your compulsive spending habits. As soon as your eyes land on that new luxury watch or those clothes you’ve always wanted to buy, your mind begs you to have it right away. Before you know it, you’ve opened up your wallets and a huge chunk of change makes its way out. Now, you’re wearing a new watch on your wrists and a face of guilt as well.
If you’re especially prone to overspending without even realizing it, you need a way to control this compulsion. That’s where the trusty 1% spending rule comes into play. The essence of the rule is a pretty straightforward concept to understand. If you want to spend your money on something that you don’t need and it costs over 1% of your annual gross income, don’t buy it right away.
Instead, you should wait at least one day before buying and seriously run through the questions below:
- Do I really need this?
- Can I afford it?
- Will I actually use it?
- Will I regret it?
If you still feel good about buying the item after you’ve considered these questions, then that’s your cue to go ahead and make the purchase. However, if your mind is hesitating on very legitimate reasons not to make the purchase, then you should put the wallet away. The 24-hour wait acts as a buffer period to let the cloudy dopamine rush diffuse and allow you to make clearer judgments.
Example of the 1% spending rule
Let’s take a look at an example. Say you’re currently an individual that makes about $70,000 in your annual gross salary. You decide to complete a few errands and go to your local mall to buy some groceries to feed yourself for the next week.
However, as you’re on your way to the supermarket, you spot a gorgeous new TV that would seriously elevate the quality of the shows you watch. Sounds nice, right? You take a look at the price tag and suck in a gasp – the price is exactly 1% of your gross annual income, at $700.
Yet, despite the high price, you can’t help but feel tempted to buy it. After all, it’s only just 1%, right? But, before you let your heart completely take over, you intelligently remember the 1% spending rule. With a sigh, you temporarily kiss the TV goodbye and head home to sleep on the decision.
Along the way, you decide to evaluate the potential purchase according to the key questions above.
1st question of the 1% rule: Do I really need this? Sure, that brand new TV would look super nice against the colors of your room. Plus, it would make the quality of the shows you watch a lot better, saving your eyes from having to squint.
However, it’s not like your current TV isn’t doing an okay job. Though it may have a few scratches here and there, you don’t necessarily need the new TV.
2nd question of the 1% rule: Can I afford it? At the moment, you might be able to afford it. But what about later on? You never know when your landlord might suddenly raise the rent of your apartment or if one of your washers will break down.
You also want to make sure that your purchase here doesn’t majorly impact your further spending and lifestyle. Because of this one TV, will you have to be living much more frugally all of a sudden?
Maybe you’ll have to take on an extra weekend job, which isn’t necessarily a bad thing. There are plenty of great ones.
Or maybe you’ll just have to take a closer look at how you’re allocating your funds. The 70/20/10 budgeting method can be super helpful with this.
But if this purchase means you’ll have to eat double the amount of instant Ramen bowls, then it might not be worth your health.
3rd question of the 1% rule: Will I actually use it? A lot of the time, we buy things because our emotions take over. We fail to consider that they don’t actually have much of a practical value.
Have you ever bought something that you thought you’d use but basically tossed it to the side as soon as you got home? Now that it’s sitting there collecting dust, you’ve probably stewed in regret with every glance.
Let’s think about the TV again. Even though it might heighten the quality of the videos and shows you watch, you don’t even have too much time to sit down in front of the TV in the first place. It’s your busy work schedule that prevents you from even taking full advantage of your old TV at all.
Plus, thanks to modern technology, you’ve started to rely increasingly on your phone for all your streaming and entertainment needs.
So, all lifestyle factors considered, it’s unlikely that you’ll actually use your new TV to its full worth.
4th question of the 1% rule: Will I regret it? If you don’t need this TV, can’t afford it, and will most likely not use it, you can heavily bet that you’ll regret it too, later on. After all, what you’re spending isn’t loose change.
Seeing that unused TV every day with its black screen staring back at you might become a constant painful reminder of a decision you made too quickly.
After a night of peaceful sleep, you wake up refreshed and ready to decide once and for all if you want that TV.
Thankfully, your analysis of the questions helps you determine that you should leave the TV in the store where it belongs.
3. The 30-day spending rule
The 30-day spending rule is a straightforward, easy-to-follow technique for reducing impulse buys and increasing your savings.
Applying the rule is quite simple: Delay your purchase.
As the name suggests, you’ll be delaying your purchase for 30 days at a minimum.
Basically, anytime you’re thinking of making a purchase or simply buying something, walk out of the store or close your browser.
It’s kind of like saying to yourself, “Not yet. Not until I get my ducks in order.”
After the 30 days have passed, go ahead and buy it if you still want it. At the very least, you’ll know you’ve made a more informed decision. You might even appreciate the item more.
Why the 30-day spending rule works
One of the most basic and frequently repeated pieces of financial advice is to save.
However, it’s a little bit like knowing you shouldn’t smoke. Despite knowing how necessary it is, many of us simply fail to implement such advice. We get it. Knowing that you should save isn’t enough. There are a lot of psychological barriers associated with it. And a large part of it comes down to core habits and associations.
The 30-day savings rule works because it is so simple. And you’re not burdened with an immediate yes or no proposition. You’re simply delaying a purchase. And that simple delay can be quite powerful.
You may have experienced in the past, even if by accident, how simply pausing and giving yourself more time to reflect can result in much better decision making. Why is that? It’s because you are eliminating emotions from your decision.
If you start to realize that your month is becoming unnecessarily difficult or annoying, you won’t have any hesitation by the end of the month to purchase the item.
If by the end of the month you realize you didn’t even think about the item, it makes it much easier to not purchase it. After all, you already didn’t purchase it for a whole 30 days!
4. The rule of 72
The rule of 72, otherwise known as Einstein’s rule of 72, is a straightforward way to calculate the time it will take for a total amount of invested money to double in value based on its fixed annual rate of interest.
To make this calculation, all you have to do is:
- Divide 72 by your estimated annual rate of return
The total value given will be the estimated amount of years it will take for your initial investment to double its value.
It’s that simple. The reason why it’s important to know this is that it gives a clear picture of what you can expect in terms of net worth or retirement savings down the line. It’s a goal to strive towards, and you can modify it based on your projected calculations.
However, keep in mind that this is only an estimate, and if your interest rate changes over time, it will invalidate your initial calculation. To account for this, you could always give an estimated average rate of return over multiple years.
The rule of 72 illustrates why it’s important to start investing early
The earlier you start investing, the more time your money has to grow. This is why Warren Buffett suggests that young people “start investing early and often.”
To illustrate, let’s say you have two friends—Jen and Rachel—who each want to retire with $1 million. Jen starts investing at age 25 and contributes $500 per month until age 65. Rachel doesn’t start investing until age 35 and contributes $750 per month until age 65. Both friends invest wisely and get a 7% annual return.
By the time Jen and Rachel, their investment portfolios have diverged quite a bit:
- Jen’s Balance: $1,328,506 ($240,500 in principle)
- Rachel’s Balance: $926,545 ($270,750 in principle)
That’s right, Jen contributed around $30,000 less overall and still ended up with over $400,000 more in the bank. Rachel doesn’t even manage to reach her goal of $1 million! How is that possible? Compounding interest.
The moral of the story is to start investing early and often. The earlier you start, the more time your money has to grow—and compounding interest will do the rest.
There is no shortcut.
But there are rules that you can familiarize yourself with to increase the odds of reaching your personal financial goals. By doing these consistently, you maximize your chances of a successful financial future.
Have you ever applied any of the rules above? And if so, how did it work out for you? Let us know, we’d love to hear from you!