The Financial Rules of Thumb
If you feel a little lost when looking at your own personal finances, there are rules that people have utilized to get themselves on the right track. Each rule can help within different areas of your finances, from housing expenses, investing your money, budgeting, and debt repayments. Everyone’s situation is different from one another, so these rules are more of a loose guideline. The more common rules are as follows:
The 28/36 Rule
The 28/36 rule indicates the maximum amount you should spend on your housing and debt payments, while still maintaining a buffer to meet your other financial obligations and goals, like living expenses, retirement savings, and working towards debt repayments. The rule states that a household should not spend more than 28% of its gross monthly incomes (before mandatory deductions) on housing expenses, and no more than 35% of its gross monthly income on all debt; including housing expenses and other recurring debt. If by chance you are spending more than the recommended 28/36 rule for the housing and recurring debt payments, it doesn’t mean a financial disaster is looming as every household is different. It is important to consider all other household expenses besides housing and recurring debt payments, however, exceeding these recommended percentages generally means less available free-monthly cash flow to meet important financial goals.
The Rule of 72
The rule of 72 is an easy calculation that will give you a rough idea of how long a sum of money would take to double, depending on interest charged or rate of return on an investment. If you invested $10,000 today, earning a "safe" return of 2% in a GIC or money market fund, according to the rule of 72, it would take roughly 36 years for your investment to double (72/2); assuming you are not adding new money to the investment. If you were able to receive a return on investment of 8% (72/8), the same sum of money would double in only 9 years. The rule of 72 can also be applied with debt. If a person owed $10,000 today on a credit card and lost their job, separated, or suffered health issues and was unable to continue payments, the balance owed could double in just under 3 years, if the interest rate was 25%. Many cards offer lower rates, however, if you find you are unable to continue payments, credit card companies reserve the right to charge higher rates as a form of penalty for missing payments.
The 50/30/20 rule
If you are looking for a new approach to budgeting, you could try to implement the 50/30/20 rule. Using this approach, you would allocate your net, after deductions, household income as follows:
50% towards "Needs": This would include expenses you must incur each month such rent, mortgage, property tax, vehicle expenses, food, childcare, insurance, utilities, and minimum required payments on other debt (besides a mortgage or vehicle loan).
30% towards "Wants": This could include vacations, dining out, alcohol/tobacco, streaming services, home renovations, recreational activities, cable, internet, and cell plans.
20% towards "Savings": This could include money allocated towards saving for an emergency fund, retirement, and debt payments over and above the required minimum payments.
Allocating 20% of net household income for savings should allow for an adequate emergency fund to be established as well as meeting other financial goals. Many budgets fail due to a lack of a proper emergency fund where you can access money for unexpected expenses or an unforeseen reduction of income, rather than utilizing credit to make up for shortfalls. Regular use of credit to make up for budget shortfalls can lead to unsustainable levels of debt.
The 20/10 rule
The 20/10 rule is a guideline to help you determine whether you are spending too much on debt excluding payments on a mortgage. Under the 20/10 rule, consumer debt (not including a mortgage) should not exceed 20% of your annual take-home pay after deductions and debt payments should not exceed 10% of your monthly take-home pay after deductions. The reason for this guideline is to ensure after debt payments, you have enough income remaining to cover all the basic necessities of life and still have income available for other financial goals such as saving for emergencies and retirement.
Being in excess of the recommended guidelines does not mean you definitely have a debt problem as other factors need to be considered such as your living situation, household income besides your own and whether future income is increasing beyond the rate of inflation.
If you feel like debt is becoming harder to service and you simply do not earn enough to ever get ahead, there are options worth considering.
If your debt is holding you back from implementing any of these rules to better your financial wellbeing, there are options.
If you are looking for advice, or a second opinion about your debt, it does not cost anything to talk about your options. Every financial situation is unique and viable options can differ from person to person. A conversation free of judgment and cost, is the first step to determine options for debt that make sense for you. For a free consultation, please call or text (506) 645-1814 or email jaime@tackledebt.ca; or visit www.tackledebt.ca.