Why Rules of Thumb Are Out of Style

There seems to be a plethora of financial ratios and rules of thumb whenever you are searching the web for an answer to a personal finance related topic. Here are some common financial rules of thumb that you may have seen or heard of:

Save 10% of your income
Have 3 to 6 months of an emergency fund
100 minus your age should be your percent exposure to equities
10 times your gross salary for life insurance death benefit
50/30/20 split for spending on needs/wants/savings

I won’t discuss all of these here, but there are many instances where each one of these rules of thumb could lead to failure. For instance, saving 10% of your income may be a fair target to shoot for, but it may not get you to be able to retire at age 60 like you have always dreamed of. If that same person, let’s say they are 30 years old, were to also follow the rule of 100 minus their age for their asset allocation, this problem is further compounded. Being that young with only 70% of their portfolio in equities could mute their returns – for such a long time period – that they can’t reach their intended goals either. Lastly, getting 10 times your gross salary in a life insurance death benefit may be far too little or far too much coverage. The answer would depend on both your age as well as what you want to make sure the death benefit covers for your family in the event of a premature death. Common examples we hear of these assurances are things like making sure their spouse doesn’t have to work again, can pay off the mortgage, or can still fund their children’s education. Responses to those questions can create a wide range of what an adequate amount of coverage is!

Take rules of thumb with a grain of salt

The main reason why you see rules of thumb in the first place is because it is a simpler way to discuss a topic to the masses. If the author can write a piece that speaks to 60% of the people reading it, they’ll likely chalk that up as mission accomplished. But my point remains that all financial rules of thumb should be taken with a grain of salt. Because, at the end of the day, they are just generalizations.

Working with an advisor

This is especially true when you are seeking or already have a relationship with a financial advisor. True financial planning should be personally tailored to your situation. Why latch on to a generic rule of thumb when it may be too tight or too loose for your specific priorities? Not to mention, this is an industry that prides itself on being able to customize each financial plan to fit your circumstances. There really is no reason to settle for generic “back of the napkin” advice when today’s financial planning software is much more robust than it used to be and can either validate or cut through each one of these generalizations.

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