Planning your finances? There are certain rules that you can break or bend
That being said, some general rules of thumb can be useful when you’re planning your finances, to guide you in your decision-making. You can fine-tune these rules depending on your situation, but they offer a good starting point.
* The six-month emergency fund rule. You should always have six months’ worth of savings on hand, in case of an emergency.
Why? Well, because it will be a big help in case something big happens in your life. Such a fund will save you from having to make desperate decisions that might set you back.
There are downsides to adhering to this rule: some analysts say that six months’ worth of savings is too much - three months is perfectly adequate; others say that there are times when an emergency fund is unnecessary altogether. There’s also the argument that, by keeping so much money in a low-to-no interest savings account, you’re missing out on a potential return.
My advice: take a look at your finances and your lifestyle, including your income, your monthly expenses and the type of emergencies that could potentially befall you. If you have adequate cover for medical emergencies, plus life and disability cover, for example, then there’s no point having a separate savings account. But do keep some money aside. It’s not nice to think about, but you never know what life has in store.
* The 4% rule. This rule of thumb states that if you withdraw 4% from your wealth portfolio annually (adjusted for inflation), your savings will last for 30 years. This is assuming that you’re invested strategically for risk: not too little and not too much.
Californian financial planner William Bengen first proposed the rule in the 1990s. He based his findings on US data that had been gathered since 1926, which showed that the average annual returns of shares and bonds were 10% and 5.3% respectively. A sensible split for a portfolio, according to him, was 50% of each.
The 4% rule still works as a guideline to help you to make decisions in complex and ever-changing markets, just remember that 4% is the pre-tax drawdown rate. Also, for the rule to work, you need to stick with it as the market moves up and down .
* 110 minus your age. There’s an old investment rule to determine how much of your portfolio should be allocated to equity and property: you should subtract your age from 100. At 65, for example, your portfolio should contain a 35% slice of equity and property, with the remainder dedicated to cash and bonds.
But the world is changing and people are living longer than ever before. As a result, most financial planners agree it’s time to adjust the rule: it’s now safer to subtract your age from 110, which will allow for better long-term growth.
This rule of thumb is a particularly good reminder of the need to rebalance your portfolio annually, so that your investment journey stays on course.
* The 20/4/10 rule. Use this rule if you must finance a vehicle. It’s always best to pay cash for a vehicle since it’s a depreciating asset, but if you must borrow, put at least 20% down. The “four” in the split refers to the duration that you should finance the car: don’t finance it for more than four years. And the “10” is the percentage of your income that you should dedicate to the repayments. In other words, don’t pay more than 10% of your income to a vehicle finance supplier each month.
This rule might limit the kind of vehicle you’ll be able to buy (maybe that luxury BMW SUV is not such a great idea), but it will prevent you from wasting money in the short term so that you’ll have more to live on in the long term.
* Don’t buy a home worth more than 2.5 to 3 times your gross annual income. Again, this is a good way to limit your spending and keep things within an affordable range. However, it doesn’t take interest rates, taxes and insurance into account. If interest rates are high, or if you’ll be spending a fortune on tax and insurance each month, consider limiting yourself to just twice your annual income.
These are all great rules, but as mentioned previously, don’t apply them blindly. It’s always best to consult with a Certified Financial Planner professional who has a bird’s-eye view of your finances and who can tailor the best solution for you so that you can maintain your lifestyle and also plan for the future.
Hardi Swart is director of Autus Private Clients and the 2019/20 Financial Planner of the Year.