5 Money Ratios to Live By
Money is tough: we all want more of it but we all feel a little unsure of how we're supposed to handle it once we get it. Enter the handy-dandy financial ratio: it does all the work for us and spits out a nice, round number that all we have to do is follow. Let's take a look at five popular money ratios and see which ones are worth buying into and which ones are total bunk:
Spend 30% of Your Income on Housing
This one comes straight from the U.S. Department of Housing and Urban Development. According to them:
The generally accepted definition of affordability is for a household to pay no more than 30 percent of its annual income on housing.
This is a good one: it will keep you in line and make sure you don't run out of money when it comes to buying groceries, paying bills, and generally living your life.
Save 10% of Your Paycheck
You'll hear different numbers here, but the important thing is to save something — anything — right off the top of your paycheck. People just starting out in the workplace will think 10% is too high, and it probably is. But as long as you're saving something every paycheck then you're doing well.
As your salary grows you'll be able to grow this number more and more. But give yourself a cushion right from the start — it'll pay off down the line.
Spend Three Months Salary on an Engagement Ring
One of my best friends told me about this one before I knew it was common advice. And this one is total crap: it preys on the fear and ignorance of guys (like myself at that time) that don't know how much they're supposed to spend on a ring. Why is it crap? Because it was started by DeBeers, the very company trying to sell you the diamond ring. How do I know it's true? I saw it on Wikipedia and everything on there is true.
The right number is unique to each person and their situation. Maybe your girlfriend doesn't care that much about this or maybe she really does. The range of possibilities is too wide to create one number that we can all go by.
Don't Spend More than 4% of Your Nest Egg
This one was filed under "conventional wisdom" until a few years ago. Right next to "you can retire when you're 65." Now with the collapse of the stock market, retirees are re-evaluating all the advice they've been hearing throughout their lives. This number might stay relatively steady, but you may have to push retirement back a few years (or permanently in some cases).
This one is similar to the saving 10% of your paycheck: as long as you're aware that the amount you're taking out of your retirement account isn't too much and that you'll have some left in the future, then you should be fine.
120 - Your Age = How Much You Should Invest in Stocks
Some people say it should be 100 - your age and some say 120. The idea is to get a nice, easy percentage so you know how much you should be in stocks and how much in bonds. I am 29 right now and I'm 100% in stocks, so that tells you that I'm very aggressive.
If you're aggressive like me, you'll want to use the 120 number. The older you get, the more you want to be in bonds so you're better protected from the gyrations of the market.
One More Thing
These numbers are handy, you can't deny that. But don't live your life by them — each person's situation is unique and you shouldn't live your life (or not live it) based on these ratios. Nobody is perfect. Keep them in mind and make sure you're going to be OK in the short and long term. And then go out there and live.
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