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Column: 8 Financial Rules of Thumb

No two people are the same, so what’s right for one person may not be for you. However, there are some financial rules of thumb that can help to steer you in the right direction, writes Liam Croke.

Liam Croke

I AM OFTEN asked a financial question that starts with the line: “As a rule of thumb what should I…” And I think the reason people start off with this statement is because they either want a shortcut to the answer they are looking for, or they want to know what others are doing.

For financial advice, giving rules of thumb, in my opinion is not the best way to operate as they are very basic and no two people are the same, so what is right for me may not be for you. Of course, they can serve a purpose and can give you a good steer but they should not be relied upon for making important financial decisions. So be warned!

Rule of thumb number 1: How much of my income should go towards my monthly mortgage or rent repayment?

My rule of thumb is the rule of 25/36.

Your mortgage repayment including insurances, should not exceed 25% of your gross monthly income or if you have other debts then when they are combined along with your mortgage repayment, should not exceed 36% of your gross monthly income.

Rule of thumb number 2: How much of an emergency fund should I have?

My rule of thumb here will vary depending on whether you are single or married, and I will tell you what I think they should be shortly, but the amount you should have in place is a multiple of your 7 biggest monthly expenses, saved in an account that can be called upon if you are made redundant or cannot work due to an accident or illness. So you should have;

  • 3 months of your 7 biggest monthly expenses for a two income household where both are in what they perceive to be stable, secure jobs.
  • 6 months of your 7 biggest monthly expenses for a single income household where the income earner is in stable, secure employment
  • 9 months of your 7 biggest monthly expenses for a two income household where both are in what are considered unstable jobs or the industry they work in is prone to volatility/redundancies
  • 12 months of your 7 biggest expenses if you are self employed

Rule of thumb number 3: How much money should I be saving each month for my retirement?

This is very important to know because I read recently that a survey was conducted where 70% of the respondents who contribute to a pension, relied on guesswork as to what their income will be when they retire. They contribute each month but have no idea whether it is enough or not!

The amount you should be saving will be dependent on a number of factors but if you want a rule of thumb try saving about half of your age as a percentage of your income. So, if you are 25 save 12.5% of your salary or if you don’t start until you are 30, save 15% of your income.

Rule of thumb number 4: How much insurance should I have?

The level of life cover you need is calculated by allowing your family to continue their current lifestyle in the event of your death, and working out exactly how much they need will depend on the number of dependents you have, their ages, your net monthly income, value of your debt outstanding, family expenses, death in service benefit etc.

Rule of thumb is 10 times your annual salary if you are in your 30s with young children. If you’re in your 40s when children might be a little older, makes it 7 times your annual salary, and, finally, 5 times your annual salary if in your 50s.

Rule of thumb number 5: How much should I borrow to buy a car?

I like the 20-4-10 rule of thumb which is 20% deposit, a loan that doesn’t last longer than 4 years and a monthly repayment that is not greater than 10% of your monthly income.

Rule of thumb number 6: How long will it take before my savings will double?

Apply the rule of 72 to this one. If you divide the interest rate you are receiving on your savings/investment into 72, then this will give you the number of years it will take for your money to double in value.

For example if your interest rate is 6%, then it will take you 12 years before your money will double in value (72/6 = 12)

Rule of thumb number 7: How long will it take before my money is halved in value?

This is obviously the reverse of doubling your money and has got to do with the effect inflation has on your savings, something I wrote about last year, where I stressed how important it was that you take notice of it and the impact it has on your savings.

Rule 70 will tell you exactly how long it will take before your money will be halved in value. You just need to divide 70 by the rate of inflation to find out. So, if inflation was 4% for example, it would take just over 17 years before your tenner is worth a fiver (70/5 = 17.5)

Rule of thumb number 8: How much of my pension contribution each month should be invested in shares?

The universal rule of thumb here is that the amount you should invest in shares as part of your pension portfolio should be equal to 100 minus your current age. So, if you are 40 years old, the % of your pension fund invested in shares should be 60%.

Liam Croke, the founder of MyMoney (www.my-money.ie), an online portal to help employees access financial information and tools to manage their finances. He is a qualified financial advisor (QFA) with over 24 years in the financial services sector. He advises organisations and people on personal finance issues of the day. He has written 5 books in the area of personal finance and has written articles for most newspapers in Ireland over the past 10 years.

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Liam Croke

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