Rules of thumb are a good starting point for getting your finances on track, so we’ve put together ten good tips to follow. However, since everyone’s situation is different, we’ve also included scenarios in which these rules are most applicable.
Budgeting
The 50/30/20 rule
This is a popular rule for breaking down your budget. The 50-30-20 rule is 50% of your income for necessities, like housing and bills; 30% for wants, like dining or entertainment; and 20% for financial goals, like paying off debt or saving for retirement.
There are looser variations to this rule, like the 80-20 rule, in which you use 20% of your income for financial goals and spend 80 percent on everything else.
Why it works: If you’re not sure where to start with a budget, breaking it up into these basic categories can be really helpful. Those percentages help create a balance between obligations, goals and splurges.
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When it doesn’t: If you’re not earning much, you might not have the luxury of only spending half your income on necessities.
You can always make a budget that’s more tailored to your situation—start from scratch and follow these budgeting steps to design a plan that works best for you.
Buying a vehicle
The 20/4/10 rule
When buying a car, you should put down at least 20%, keep your car loan limited to no more than four years (to avoid interest) and spend no more than 10% of your gross income on transportation costs.
Why it works: It keeps you from buying more vehicle than you can afford. Cars are expensive to maintain and this formula takes your ongoing vehicle budget into consideration by calculating total transportation costs. These costs include your car payment, parking, gas and insurance (which varies by vehicle type).
When it doesn’t: Depending on your situation, these numbers might not be realistic for you. For example, you might spend more than 10% of your gross income on transportation because you have a long, gas-guzzling commute to a low-paying job. Since you need your car to work, you might look elsewhere in your budget to cut costs.
The 10-year rule
This rule has to do with the decision whether to buy a car new versus used. If you want to maximize your car’s value, you should either buy used, or buy new and drive the car for ten years.
Why it works: The rule minimizes your depreciation hit—a new car loses 20 percent of its value in the first year of ownership, according to Carfax. However, buying a used car sucks minimizes the depreciation that’s already been sucked out of the vehicle. If you buy a new car and keep it for a decade, you’ll have optimized its value and the depreciation won’t matter as much.
When it doesn’t: A used car is more likely to break down and require repairs.
You’ll want to make sure the maintenance isn’t more expensive than the value of sticking with a used car.
Generally speaking, research is important in considering all the variables. Edmund’s has an affordability calculator, and we’ve written about the four questions you should ask when deciding on a new versus used vehicle.
Homeownership
The 20% rule
You should put at least 20% down when buying a home.
Why it works: It ensures that you don’t buy more home than you can afford, lowers your monthly mortgage cost, and can increase your chances of being approved for the loan. You also won’t have to pay private mortgage insurance.
When it doesn’t: While this is commonly accepted as practical advice, opinions can vary. Some consider 20% unrealistic as it’s an overwhelming amount to save.
The income rule
Don’t buy a house that costs more than three years’ worth of your gross annual income. Some variations say no more than two years; others say two and a half.
Why it works: It puts a ballpark limit on how much home you can (or should) afford.
When it doesn’t: This rule doesn’t consider how much money you have in reserve, so it might make more sense to consider your net worth rather than your income. And another factor would be living in a large city where houses are more expensive but still offer value long-term as an investment.
These general rules give you an approximate amount to start with when thinking about homeownership. But there’s a long list of expenses, including closing costs, to consider, too. And it all varies. Check out our list of homeownership expenses that you might overlook before you start looking.
Retirement
The 10% rule
“Save 10% of your income for retirement” is a very common rule of thumb.
Why it works: It gives people a simple number to work with. If you’re young, just opened a 401(k), and you’re not sure how much of your earnings to set aside, 10% is a good start.
When it doesn’t: While 10% is a simple rule to follow, the percentage doesn’t consider how much you’ll actually need in retirement. It also doesn’t consider how much you’ve currently saved. If you’re playing catch-up, you’ll probably need to save considerably more than 10% of your income. Similarly, if you want to retire early, or more lavishly, you’ll likely need to save more than 10%.
The income rule
You should save 20x your gross annual income.
Why it works: It helps you focus on what you’ll need in the future.
When it doesn’t: It’s more of a common benchmark than a one-size-fits-all formula. Your retirement expenses might differ from how much income you earn now, and depending on the lifestyle you plan to live, you may need a lot more (or less) than 20x your income.
These retirement rules offer ballpark numbers, but if you want a more accurate approach that considers all the variables, develop a detailed vision your retirement. Then, calculate how much that lifestyle will cost.
Student Loans
The first-year salary rule
You shouldn’t take out more in student loans than you expect to make your first year on the job.
Why it works: It ensures you’re taking out an affordable amount that you’ll be able to repay.
When it doesn’t: Skyrocketing tuition rates have made following this rule a challenge, as have unemployment rates right after graduation.
This is a sticky and complicated topic. As we’re in the middle of a student debt crisis, not to mention a recession, it’s easy to dismiss this rule. But it’s important to have a realistic idea of what your income and repayment are going to look like after college, especially as it relates to your major. You’ll also want to compare the cost of an education at different universities to get a better idea of what you can afford.
Saving and investing
The 6-month emergency fund rule
You should have six months’ worth of savings on hand in case of an emergency.
Why it works: Obviously, this is a big help in case an emergency arises in your life. It keeps you from having to make desperate decisions that can set you back.
Why it doesn’t: There are many different opinions on how much you should saved, but as we know from the pandemic, even this may not be enough.
It’s can be really hard to hear “you should save an emergency fund” when you’re broke, so with that in mind here’s a Lifehacker post on alternative ways to get some emergency cash.
The age rule for stocks
When investing, bonds are generally less risky than stocks. So the rule follows that the older you get, the less you should invest in stocks. To put a number on it, subtract your age from 120 (the old rule was 100, but many experts now say 120 makes more sense); that’s the percentage of your portfolio that should be invested in stocks.
Why it works: It gives you a general idea of what your asset allocation should look like, based on your age.
Why it doesn’t: This rule doesn’t consider the incredibly low interest rates we have had to contend with in recent years. It also assumes your retirement based on your age. If you’re planning to retire sooner, you’ll need to adjust.
If you want to get a better idea of how much you should have saved in stocks and bonds, consider using an online tool like Portfolio Visualizer or Personal Capital to help you visualize your retirement planning.
Most of these rules are pretty solid, tried-and-true methods for planning your finances. But again, personal finance is, well, personal. Consider these rules a good starting point—to really stay on top of your finances, research and personalized planning is a necessity.
This story was originally published in December 2014 and was updated on October 30, 2020 to update links and include new information.
