Learning the right way to budget is essential for building your wealth and being well on the way to financial security. If you’ve been looking for money management tips, then you’ve likely stumbled upon a few rules, like the rule of 72 or the 50/30/20 budgeting rule. These are excellent for helping you control your spending and portion your money to have enough set aside for your necessities and savings.
However, a few other rules can also help you build your wealth and fit your financial situation better. By understanding them, you’ll know which one to use for a particular circumstance. Here are four financial principles to consider and their pros and cons:
The Rule of 25
If you aren’t sure how much you’ll need to retire comfortably, you may want to follow the rule of 25. The first thing you need to do is decide how much income you’ll need for your ideal retirement lifestyle. Then, multiply that number by 25, which is the amount you’ll need to achieve it.
American financial planner William Bengen created this rule in the 1990s. While it is meant to help you set aside money for your savings, it also has some disadvantages, as it assumes that your retirement income will be derived from your private savings. However, according to the Australian Bureau of Statistics (ABS), almost one in two Australian retirees receive at least a partial age pension. The rule was also based on a remarkably conservative portfolio of investments when interest rates were much higher than they are today.
The Rule of 72
If you’re hoping to grow your wealth through investing, this is a rule you’ll want to follow. It demonstrates how long it takes for investments to double. All you have to do is divide 72 by the annual return your money makes, and the result is the years it will take you to double your money.
The rule was crafted using a complex equation for compounding returns. Although 69.3 offers a more accurate figure, 72 was chosen since it was easier for mental arithmetic when smartphone calculators were yet to be invented. The main drawback of this rule is that returns can fluctuate wildly from one year to the next, which is why this rule must be regarded only as a guideline.
The 50/30/20 Budgeting Rule
This rule offers a straightforward way to divide your paycheque once you receive it. After accounting for tax, 50 per cent of your salary goes to your living costs, 30 per cent is for discretionary spending, and 20 per cent goes to your savings and investments. The rule is fairly simple to follow, which is its primary appeal.
However, the downside is that it doesn’t account for individual circumstances. If you’re saving to buy your first home, you’ll want to put more than 20 per cent of your income into your savings. Additionally, if you earn a low income, spending a third of your income on new clothes or indulgent food may be impractical. For this reason, it’s best to go for a division that works best for you, like 60/20/20 or 50/20/30. You can also consult a financial adviser in Queensland to help you find the most suitable proportion.
Six Months’ Worth of Expenses For Your Emergency Fund
Everyone saves for a rainy day, and having a significant amount of savings will prevent you from slipping into financial trouble in the event of an emergency. The previous benchmark used to be three months’ worth of living expenses, although the pandemic has shown that anything can happen, leaving you potentially without income for half a year or more.
Still, whether you have three or six months worth of living expenses saved up, it provides you with a financial safety net. If you suddenly lose your job or are no longer able to work due to severe illness, you won’t have to scramble to pay the bills. Unfortunately, this budgeting rule isn’t feasible for everyone, as it requires the individual to take out a sizeable portion of their income every month. If you’re a low-income earner, this won’t be very practical.
These financial principles can get you started with budgeting your money wisely, saving enough for retirement, and having a sizeable emergency fund. By following these money management tips, you’ll be closer to financial stability than ever before.
Swell Financial Planning is a firm consisting of financial consultants and wealth advisers in Queensland. We help clients gain clarity and control of their finances through our services of budgeting and cash flow advice, wealth protection and insurance advice, and more. Contact us today to get started!