The past year has been a wild economic ride. Inflation reached record highs, hitting consumers where it hurt. Meanwhile, the Federal Reserve increased the federal funds rate seven times in 2022—effectively making it more expensive to borrow money. As a result of all this, some tried-and-true financial rules sort of went out the window.
Now for a bright spot: Things seem to be normalizing a bit. Measures by the Federal Reserve to control inflation saw some success in December, and interest rates are bouncing back on investments from the near-zero rates that lasted for years. Some old financial rules of thumb are now also making a comeback. Find out which ones and how they might strengthen your financial portfolio.
1. The Rule of 72
The rule of 72 is used to estimate how many years it will take for an investment to double in value. The formula has you take 72 and divide it by your expected rate of return. It isn't perfect, but it can provide a ballpark idea of how your investment might grow.
One drawback is that the rule works best with an 8% expected rate of return. In low-rate environments—like we saw from 2020 to early 2022—the rule of 72 was less relevant for certain investments.
The Fed funds rate affects different investments in different ways. When it goes down, stock market returns tend to increase (and vice versa). Returns on bonds, certificates of deposit (CDs), money market accounts and high-yield savings accounts are a different story. These yields tend to mirror the direction of the funds rate. When it increases, these yields usually follow suit.
This is all to say that the rule of 72 might be relevant again if your investments are hovering around the 8% expected return mark. You might use the rule of 71 for expected returns of 5% to 7%, or the rule of 73 for expected returns of 9% to 11%.
2. Investing in I Bonds
Inflation isn't great for your budget, but you might use it to your advantage when investing. Series I bonds use a combination of two different interest rates. One is a fixed rate that doesn't change; the other is a fluctuating rate that bounces up and down with inflation. This allows investors to earn interest that outpaces inflation. Series I bonds purchased until April 30, 2023, have a 6.89% guaranteed return, according to TreasuryDirect.
Series I bonds are still considered conservative investments. To meet your long-term financial goals, you might also choose to incorporate higher-risk investments such as stocks. That said, series I bonds can help diversify your investment portfolio.
Treasury bonds are generally worth exploring in a high-rates environment. At the end of 2020, when interest rates were particularly low, the yield on a 10-year treasury note was just 0.92%. That number jumped to 3.88% by the end of 2022, more than doubling in just one year.
3. Relying on CDs
A certificate of deposit is a special type of savings account that rewards you for leaving your money in the account for a predetermined amount of time, known as the maturity period. It's a low-risk investment, and longer maturity periods usually unlock higher yields. But if you tap your funds before that period is up, you'll be penalized.
In April 2021, the average yield on a 60-month CD was just 0.28% annual percentage yield (APY), according to the Federal Deposit Insurance Corporation (FDIC). That number is up to 1.21% APY as of January 2023. A little digging will likely uncover even better rates. Marcus by Goldman Sachs, for example, is offering 3.80% for 60-month CDs as of January 25, 2023.
4. Leveraging Money Market Accounts and High-Yield Savings Accounts
Money market accounts provide liquidity like a checking account while earning interest like a savings account. Most come with a debit card or checkbook to make it easy to withdraw funds, though some financial institutions do limit customers to six electronic withdrawals or transfers per month. The FDIC puts the average rate for a money market account holding between $10,000 and $100,000 at 0.44% APY. That's up from 0.10% in April 2021. Again, higher rates are out there. Some banks are currently offering as much as 4.25% APY.
High-yield savings accounts are interest-earning accounts that typically have a higher rate than traditional savings accounts, so you earn more even if your money's just sitting in the account. They're usually offered by online banks that operate mostly (or completely) online. That means physical branches may be limited or unavailable, but the high APYs can help your money work a little harder for you. Barclays, for example, is currently offering a 3.40% yield.
What Rules of Thumb Are Likely Gone for Good?
While some old personal finance rules are coming back, others might be a thing of the past. The following are either gone for good or changing in this new economic normal.
The 60/40 Portfolio
A diversified investment portfolio reflects a mix of different assets. That can include stocks, bonds, exchange-traded funds (ETFs), mutual funds, index funds and more. Holding 60% stocks and 40% bonds has long been seen as a moderate or balanced portfolio. (Again, stocks are considered riskier than bonds.) But things are changing.
According to J.P. Morgan, returns for the 60/40 portfolio declined 16.1% during the first half of 2022. Adjusting your investment strategy may be necessary to reach your financial goals. The right asset allocation for you will depend on your risk tolerance and investment timeline.
Set-in-Stone Budgeting Rules
There are lots of different budgeting rules out there. The 50/30/20 approach allocates your take-home pay like this:
- 50% for essentials
- 30% for flexible spending
- 20% for financial goals
It's a good template, but today's economic conditions may require more flexibility. Thanks to inflation, $100 today won't buy you as many groceries as it did a year ago. The cost of borrowing money has also increased. During the fourth quarter of 2022, the average credit card annual percentage rate (APR) was over 20%, according to preliminary data from the Federal Reserve. That's up from 16.28% during Q4 2020. An effective budget is one that can respond to economic conditions and your personal financial situation as needed.
The Bottom Line
Financial rules of thumb are handy when they work. They can provide some structure and a sense of control over your money. But, like anything else, they aren't set in stone. Economic conditions change—and you need to be able to adapt.
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