The personal finance thumb rules in “Buy This, Not That“ offer an ambitious, yet strategic approach to building wealth and financial independence. While these rules are aggressive, they make sense for anyone looking to establish strong financial security and freedom. Here’s a breakdown of these rules, each aimed at accelerating your financial independence goals.
Defining Financial Freedom
Financial Independence (FI) Net Worth Target:
Financial independence is defined as having a net worth between 25x your annual expenses and 20x your annual income, or passive income covering your best-life budget.
Freedom Gap:
This is the difference between your expenses and passive income. A gap indicates how much more passive income you need to close it.
Net Worth Milestones and Risk Tolerance
Net Worth Growth Milestones:
2x income by 30
5x income by 35
10x income by 40
15x income by 50
20x income by 60
These milestones are ambitious but provide a powerful financial cushion and income-generating ability over time.
Risk Tolerance Formula:
Determine how many months you could work if you lost all your equity investments:
Risk Tolerance = (Public Equity Exposure × 35%) / Monthly Gross Income
Maximum Equity Exposure:
To calculate the maximum you should allocate to equities:
Max Equity Exposure = (Monthly Salary × Risk Tolerance (in months)) / Potential Percentage Decline in Market
Savings and Investment Strategies
Max Out Tax-Advantaged Accounts:
Prioritize tax-advantaged retirement accounts, then aim to save at least 20% of your remaining income. This disciplined approach can fast-track financial freedom.
Passive Income Timeline:
Generating passive income that covers living expenses may take 10 to 30 years, depending on your savings rate and investment growth. This timeline may seem long, but it’s realistic and aligns with aggressive saving principles, so the best time to start on your passive income is now.
Debt and Car Purchase Rules
Car Purchase Rule:
Spend no more than 10% of your gross annual income on a car to prevent over-investing in depreciating assets.
Debt Paydown Rule:
Allocate part of your cash flow toward debt repayment using this rule:
Debt Repayment Allocation = (Debt Interest Rate × 10%) of Cash Flows After Living Expenses
Ideal Asset to Liability Ratios by Age:
20s: 2:1 ratio, target net worth of $250k by age 30
30s: 3:1 ratio, target net worth of $650k by age 40
40s: 5:1 ratio, target net worth of $1.25M by age 50
50s: 8:1 ratio, target net worth of $2.2M by age 60
Retirement: 10:1 ratio
Investment Allocation
Index Fund Allocation:
Allocate 80% of your equity exposure to index funds for a safer, diversified approach.
Speculative Investments:
Limit speculative investments to 5% of your net worth to mitigate risk while leaving room for potential high returns.
Home-Buying Rules
30/30/3 Home-Buying Rule:
Spend no more than 30% of your gross monthly income on your mortgage.
Have at least 30% of the home’s value saved in liquid assets.
Limit the home’s value to 3x your annual income.
Mortgage Term:
A 15-year mortgage term is generally superior due to lower interest rates and faster payoff, minimizing interest costs over time.
When to Not Pay Down Mortgage:
Avoid paying down your mortgage if:
The interest rate is less than or equal to the 10-year Treasury bond yield or the inflation rate.
BURL Rule:
Buy utility real estate and rent luxury real estate.
Housing and Rental Property Guidelines
Ideal Home Size:
Aim for 600 to 800 sq. ft. per person. For a family of four, this translates to 2,400 to 3,200 sq. ft..
Housing Expense Limit:
Keep housing expenses within 20% of your gross monthly income.
Rental Property Goal:
A goal could be to own one property per family member. Purchasing property when children are young can lead to debt-free ownership by the time they reach adulthood.
Vacation Property Rule:
Spend no more than 10% of your net worth on a vacation property.
Parenting and Private School Affordability
Parenting Time:
The average time spent with kids per day is 120 minutes for moms and 85 minutes for dads. To balance work and parenting, aim to exceed these averages.
Private School Rule:
Your household income should be at least 7x the annual net tuition per child before considering private school to avoid financial strain.
Conclusion
These thumb rules are aggressive yet sensible for anyone striving to build wealth and financial independence. They provide a structured, disciplined approach to spending, investing, and managing debt that sets you on a faster track toward financial freedom, securing a foundation that can withstand life’s challenges.
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