Last year, there was a post circulating on social media with a frum individual’s salary and the breakdown of how it is all spent. It highlighted the percentage of his salary that went to taxes, yeshiva tuition, housing, retirement, vacations, cars, and more. It provided a quick and interesting snapshot into one person’s finances. Naturally, it made others in the frum community wonder how their finances compared.
Am I spending too much on housing costs? Am I saving enough? Can I afford to retire? These are all questions about which folks wonder, but many aren’t sure how to answer. While everybody’s personal finances and spending patterns are different, there are certain quick rules of thumb that can provide a framework for, or quick assessment of, your finances.
This week I’ve decided to compile some popular rules of thumb to share with readers and offer my own thoughts on the relevance of each rule. Keep in mind that it’s OK if your personal situation doesn’t alight exactly with every rule. After all, these are by definition overly general guidelines. Some of them may not be applicable to your life. However, if your circumstances are totally out of whack relative to many of these rules, it may be worth reviewing your finances and hiring a professional to help you make the appropriate adjustments.
Three to six months’ worth of expense money in your emergency fund: An emergency fund, or a pool of money sitting in cash that is available for expenses, is one of the cornerstones of financial planning. It is imperative that every person maintains an adequate balance to cover their expenses in case of an emergency, including job loss, illness, or unforeseen expenses. Three to six months of expense money is a good starting point, though depending on personal circumstances some folks may consider keeping more than that.
50/20/30 Rule: A typical budgeting framework states that you should spend up to 50% of your after-tax income on needs and obligations, such as putting food on the table and yeshiva tuition. 20% should be set aside and invested. The remaining 30% should be spent on debt repayment and anything leftover on whatever you want.
This is a good rule, but it should be modified for the frum community to 50/20/20/10. The new bucket takes 10% away from the discretionary spending category and earmarks it for tzedakah. The challenge in the Orthodox Jewish community is that many people don’t have the luxury of extra cash flow to spend on other items. Discretionary funds are often needed to afford maintaining a frum lifestyle. However, I think all readers will agree that there is no better usage of funds than that.
Limits on housing costs: A person’s mortgage, including taxes and insurance, should not exceed 30% of gross monthly income. This is a good rule. If your housing costs are much more expensive, consider moving to a location where the housing prices are cheaper. While moving is never easy, it will likely offload a huge amount of financial pressure and improve your quality of life, as well.
Automobile rules of thumb: 1) Limit car payments to 10% of your monthly net pay. 2) Keep your total car costs, including gas, insurance, repairs, and maintenance, below 20% of your income. 3) When buying a car, put 20% down and limit the loan term to four years. 4) If repair costs are more than your car is worth, which can be determined by Kelley Blue Book, or exceed one year’s worth of monthly payments, then replace the car.
My view on cars is that they can derail your finances if done wrong. A car’s primary function is to get you and your family from point A to point B. It is not a status symbol. Most people should never own or lease a luxury car. Additionally, it is rarely a necessity for one family to have more than two automobiles. More can be said on each of these points, but if you stick within this framework, you will probably make the right decision.
Total debt: All debt payments, including mortgage, should be less than 36% of monthly gross income. Remember, as a general rule, debt should be avoided. For most people, debt will erode their finances and impede their ability to grow their wealth. Over time you should work to eliminate all your debts.
When is it appropriate to have credit card debt: Never! Avoid! And pay off all credit card debt you have today!
Rule of 10: A helpful framework for large discretionary purchases is to reflect on how it will make you feel in 10 days, 10 weeks, and 10 years. Having the proper perspective can calm buying urges for purchases you will later regret. In the age of Amazon and overnight delivery, taking a breath and thinking through big purchases is a worthwhile exercise.
100 minus your age for your portfolio: I would recommend taking this rule of thumb with a grain of salt. The “100 minus your age” rule is a benchmark for how to split your investment portfolio across stocks and bonds. Per the rule, you subtract your age from 100 to arrive at the percentage you should invest in stocks, with the balance allocated to bonds.
The purpose of this rule is to maintain a balanced portfolio between volatile and growth assets (i.e. stocks) and typically more conservative and less volatile assets (i.e. bonds). As one gets older and closer to retirement, they will shift more money into bonds and supposedly take less risk. While theoretically sound, the issue with this rule is in the year assumption. People are living longer than ever, which may necessitate having more stock exposure in one’s portfolio even in retirement in order to outpace inflation. It’s realistic to have a 30 or 40-year retirement (or even longer), so holding too much in bonds may cause an investor to prematurely exhaust their funds.
Furthermore, everybody’s situation is different and income sources may vary over time. Therefore, taking a more dynamic and hands on approach to portfolio construction makes the most sense.
Rule of 72: This rule allows you to determine approximately how long it will take you to double your money by dividing 72 by your expected annual rate of return. For example, with a 6% annual return, an investment will double in approximately 12 years (i.e. 72 divided by 6). This is useful for quick mental math to assess the growth of one’s account assuming no additional contributions.
10x your gross annual income for life insurance: This rule is far too general. Practically, the appropriate level of coverage depends on your individual needs. Additionally, your income will likely increase significantly from 25 to 55, which would translate to getting more life insurance according to this rule. However, the exact opposite is often true, with less life insurance needed when you are older.
I have found it to be more helpful to approximate your needs and expenses based on lifestyle choices. Purchasing a relatively cheap 30-year term policy based on your anticipated needs, even while you are young and have a modest income, can help protect your family for decades in the future. Additional life insurance can be added, if necessary, down the road.
Saving 15% of income for retirement: This rule doesn’t exactly jive with a previous point on budgeting. However, if you can save and invest 15% of your income every year for your entire 40-to-50-year career, and do so in a tax advantaged retirement account, you should be quite financially comfortable by the time you retire.
Replacing about 70% of your pre-retirement income in retirement: Folks planning for retirement often ask me how much income they will need to maintain their lifestyle in retirement. The answer is not always simple. Certain expenses, like tuition, raising kids, and housing costs, will hopefully be less. Other expenses will eventually increase, like healthcare or long-term care. However, for planning purposes, assuming you will need 70% of your pre-retirement income may be a good starting point.
4% safe withdrawal rate: A question I often receive from clients is how much they can pull from their retirement accounts without running out of funds. That’s when the 4% withdrawal rate comes into play. If your portfolio is structured appropriately, you may be able to safely withdraw 4% of the money in your portfolio every year without exhausting your funds. Please note: There are many (read: MANY) factors that come into play when determining a truly safe withdrawal rate. 4% is merely a helpful framework to think about spending in retirement.
When can I retire? Not a week goes by where I don’t get this question. A quick and simple rule of thumb is that you should be able to comfortably retire when your savings are at least 25 times your annual expenses. Obviously, this depends on your age, expenses, and other sources of income, but this is a minimum benchmark for which to strive.
The good thing about rules of thumb is that they allow for quick assessments to ensure that you are on track to achieve your financial objectives. Hopefully, this article provided you with either peace of mind or revealed flaws in your current strategy. Either way, you should now have some clarity on general guidelines on how to proceed going forward.
