I know not everyone is good with numbers. *How many zeros are there in 1 million, again?* Unfortunately, it’s hard to avoid numbers when dealing with money and personal finance. Luckily, you don’t need to be a mathematician to understand personal finance.
Know These Numbers to be Financially Literate
There are certain numbers that you should recognize if you want to become more financially literate. Some of these numbers are hard numbers to be aware of, while others may act as guidelines to better manage your financial future.
The following isn’t a list of arbitrary numbers that you should “know” to better understand your finances, such as net worth, cash flow, investment returns, and fees, etc… These are all important number you definitely should know and that I will probably cover in a later article, but they differ greatly between each individual.
The numbers I’ll be covering in this article are all hard numbers that have an impact on everyone. It’s important to recognize all these numbers and how they play a part in your financial picture.
Table of Contents
3% is the number I like to use when calculating average inflation. Some may argue that 3% is on the high side, especially since average inflation for the last 2 decades is closer to 2%. However, if you look at the last century, inflation is closer to 3% and I would rather be more conservative than aggressive.
What is inflation?
Inflation is defined by the general increase in the price of goods and a decrease in the purchasing power of money. In the U.S., inflation rates come from the Consumer Price Index, which tracks the price of goods from a variety of goods and services.
Inflation is a powerful force and an important concept to understand if you want to plan your financial future.
It’s responsible for your grandmother whining “Back in my day, a candy bar only costs 10 cents!”
More importantly, it’s responsible for the gradual disappearance of the McDonald’s Dollar Menu. Ok, maybe that’s not the most important example…
Why is inflation important to understand?
It’s important to keep inflation in mind when planning your retirement future. As an example, if you tell yourself you’d be happy with $1 million to retire today, you would actually need $2.5 million to retire in 30 years.
One of my favorite places to play with inflation planning (and see historical inflation rates) is SmartAsset’s Inflation Calculator.
4 (or 25)
4% is a rule of thumb regarding how much of your retirement assets you can safely withdraw in your first year of retirement and have it last for at least 30 years. Another way people view it is you should have 25 times your first-year retirement spending in assets for you to safely withdraw 4% each year.
Where did the 4% rule come from?
The 4% rule first gained traction by financial advisor William Bengen in 1994, where he studied how retirement portfolios would perform during various market conditions. He concluded that even in the worse historical market conditions, the 4% rule would allow a retirement portfolio to last for at least 30 years.
The 4% rule was also later popularized by the “Trinity study” in 1998.
4% rule controversy
There is a constant debate in the finance community whether the 4% rule is too aggressive of a withdrawal rate to last through retirement. Others also argue that it is too conservative and that you can withdraw more.
It’s important to keep in mind there are various factors that affect your safe withdrawal rate. One of the most important things is whether or not you retire during or near an economic downturn. Another important factor is how long you want the money to last.
Like a lot of things with personal finance, your retirement withdrawal rate is a very personal number and what will work for you may not work for someone else. While I believe the 4% rule is a valid starting point, it is important to evaluate your own scenario and run the numbers yourself or with a financial professional.
15% is the tax rate for long-term capital gains for most people. It can reach 20%, but only if your income is higher than $434,550 for a single filer in 2019.
Long-term capital gains tax is the tax applied to assets held for more than a year.
Why is this important to know?
If you sell an asset you’ve held for less than a year and make a profit, it is considered short-term capital gains and the profit is taxed at your ordinary income tax rate. For most people, that is a lot higher than 15%.
What does this mean?
You get to keep more of your profit if you hold onto your assets for more than a year because it is taxed at a lower rate. So if you start investing in stocks and mutual funds in a taxable account, this is an important concept to keep in mind.
50 is the age where you are allowed catch-up contributions in your tax-advantaged retirement accounts, such as IRA and 401K.
The normal contribution limits in 2019 for the IRA/Roth IRA is $6000 and $19,000 for the 401K/Roth 401K.
With catch-up contributions, you are allowed to contribute an extra $1000 into your IRAs and an extra $6000 in your 401Ks. This makes the total you can contribute to your IRAs $7000 and $25,000 for your 401Ks.
This is great if you happened to get a late start saving for retirement and need more places to keep tax-advantaged retirement money. Granted, it is dependent on the fact that you are already maxing out your retirement accounts in the first place to take advantage of the extra contribution limit.
62 is the age when you can begin drawing Social Security benefits.
However, this does not necessarily mean that you should. If you start taking Social Security benefits at age 62, your benefits are reduced by 30% from your full retirement age benefits (discussed next).
For each year you wait after age 62, the benefit amount that you receive increases. It’s important to realize that the age you start claiming Social Security impacts the benefit amount for the rest of your life.
For example, if your full retirement age benefit is $1000/mo, but you claim Social Security early at age 62, your Social Security benefit will only be $700/mo FOR THE REST OF YOUR LIFE (adjusted for inflation annually). It will not jump back up to $1000/mo when you reach full retirement age.
Therefore, the longer you can wait to claim Social Security, the more money you will receive each year. That is until you reach…
For most readers of this blog, full retirement age set at 67 years old. This is what the Social Security Administration defines for anyone born after 1960.
This is the age where your Social Security benefits reach 100%. However, your Social Security benefit amount will continue to increase to 132% of your full benefit if you delay claiming until the age of 70. In other words, the different in Social Security benefit between someone who claims at age 62 compared to someone who claims at age 70 will be over 75% more!
A good resource for understanding how claiming Social Security early impacts your benefits is the Social Security Administration website.
70 ½ is the age where most people need to take required minimum distributions (RMD) from their tax-advantaged retirement accounts, such as IRA and 401K. Oddly enough, Roth 401Ks are required to take RMDs, but Roth IRAs are not.
What are Required Minimum Distributions (RMDs)?
An RMD is the minimum amount that must be distributed to you from your retirement accounts each year. There are stiff tax penalties associated with not taking the appropriate amount of distribution from your retirement accounts.
As a side note, you are always allowed to take out more money than the RMD.
The Rule of 72 is a fast and easy way to estimate how long an investment return will take to double in value.
How Does the Rule of 72 Work?
To determine how long an investment return will take to double in value, divide 72 by the anticipated investment return. This will give you how many years it will take to double your money.
For example, if you expect your investment to return 10% annually, take 72 / 10 = 7.2. This means your investment will double in 7.2 years.
Likewise, if you expect your investment to return 6% annually, it will take 12 years for your investment to double (72 / 6 = 12).
Keep in mind, investment returns hardly ever return the same number every year and this calculation is only an estimate.
A number greater than 750 is generally where you want your credit score to be in order to be considered excellent credit.
These days, there are a few different credit score models and how they categorize their brackets. Traditionally, 850 is the highest score that you can get with your credit score.
By having a good credit score, you ensure that you can get the most competitive rates for financial products such as a mortgage or car loans, eventually saving you thousands of dollars in interest charges.
It is also important to have a good credit score as employers these days can sometimes look at it as a factor to hire you or not. This varies between companies and industries.
If you do not know what your credit score is, you can find out for free at Credit Sesame.
50 / 30 / 20
50/30/20 is a simple budgeting system that splits your spending into 3 main categories. Essentially, 50% of your post-tax income should be allocated to NEEDS, 30% should be allocated to WANTS, and 20% should be allocated to SAVINGs.
Needs include things such as rent/mortgage payments, car payments, debt payments, groceries, utilities, and healthcare.
Wants include non-essential spending. Things such as eating out, shopping, and entertainment. This should be the first category you should look at cutting back on if you can’t make the rest of your budget work.
Savings include both short term savings, such as an emergency fund, and long term savings, such as retirement accounts.
I personally would recommend more than 20% for all these things, but agree that 20% is a good place to start.
Keep in mind that this is just one type of budgeting system and that it may or may not be the right one for you. If you decide to go with it, view it as a suggestion and adapt it so that it fits your budget and lifestyle.
20 / 4 / 10
20/4/10 is another rule of thumb aimed at how much car you can afford to buy. Here’s how it works.
20% Down Payment
You should aim to have enough money saved to put down 20% of the car’s price as a down payment. This ensures that you won’t “upside-down”(owing more than it’s worth) on your car the moment you drive it off the lot.
4 Year Car Loan
You should avoid getting a car loan term that is longer than 4 years. While your monthly car payments will be higher the shorter the loan term is, this will save you money on interest payments over the life of the loan.
It will also prevent you from having a “forever payment”. Some people these days are taking out loans for 7 years!
10% of Monthly Income
Your total car costs (including payment, insurance, parking, registration, repairs, etc…) should not exceed 10% of your gross monthly income.
All three of these factors combined will help control how much you spend on a car and prevent you from buying a car out of your price range. Similar to the 50/30/20 budget system, it’s important to use this as a starting recommendation and determine if it makes sense for your own situation.
I hope I’ve brought some light to certain numbers you should recognize if you want to be fluent in financial literacy. Recognizing these numbers and understanding why they’re important can help you better plan for your financial future.
I’ve only briefly touched on many of them in this article, but each of them is probably deserving of this own article. I encourage you to dive deeper and learn about the ones that you may have not been familiar with. Educating yourself if one of the best things you can do to better manage your money.
Did you learn anything from my list of numbers? Are there any numbers you think belong on this list? Share your thoughts in the comments below.