“Give me a nickel, brother can you spare a dime? Money can drive some people out of their minds” -The O’Jays

What is a rule of thumb when it comes to money? It can be a way of helping you save for retirement, how you should invest your money, or how much life insurance you should carry on yourself. They can be extremely helpful for general knowledge, but they DON’T take into consideration the individual needs of families that want to apply them. Here are just a few rules of thumb, and how they may fall short when it comes to everyday use:

1. The Age Rule

How much should you hold in stocks in your 401k? There’s a rule of thumb that suggests you simply subtract your age from 100, and that percentage of your account should be invested in the stock market, with the rest making up cash or other fixed investments.

• Pro: It’s a quick and easy way to start investing, with very little work involved.
• Con: Unfortunately, this guideline doesn’t take into consideration your individual risk tolerance. Some of my most conservative clients are younger and just starting their financial planning, while some older clients are willing to take on much more risk. Age should not be the only thing to consider when investing for your future goals.

2. Purchase 10 Times Your Salary in Life Insurance

I have actually heard this rule of thumb from a lot of advisors that started out in either Morgan Stanley or Merrill Lynch. I’m not sure who started this idea, but there are just too many holes to poke in this thought process:

• Pro: Something is better than nothing, and surely $1M in term coverage (for a median income of $95,995 in the DC area) would replace a significant portion of future income.
• Con: This idea doesn’t take into consideration individual circumstances that could significantly increase or even decrease the amount that would be needed if you died. What if you had a child with special needs, or a parent that still needs to be cared for after you die. Let’s assume you are married, and both of you are extremely high income earners. Would you even need to replace any income? It all depends, because everyone’s situation is different.

3. Hold 6 Months of Emergency Funds in Savings

I LOVE the idea of having an emergency fund, but where did the figure of 6 months of your salary even come from?

• Pro: The Bureau of Labor Statistics states that the average amount of time someone is unemployed and looking for work in the US is 22.1 weeks, which is about 5 and a half months. 6 months would be a great start for emergency savings if you only had possible unemployment to worry about.
• Con: This rule doesn’t take into account all of the “what if’s” in life. What if you needed a new car to get to work? What if your roof needed repairs? What if you become disabled? What if all of the above happened: would 6 months of income cover everything? When disaster strikes, it can ruin even the best laid plans. That’s why it’s important to view the 6 months rule as a starting point.

4. Rule of 72

This is one of the first rules I actually learned in college courses. Divide the average annual return of an account into 72, and that would be how many years it takes for your money to double. If it’s a 6% return, it would be 12 years, and 18 years for 4% and so on. Is this rule practical though?

• Pro: It’s a quick way of seeing how important return and time can be in an investment. If you have more time to invest for a goal, then you wouldn’t need a significant return rate. With time on your side, you can reduce risk of market fluctuations.
• Con: The math just doesn’t add up. This rule of thumb doesn’t work for a lot of real world scenarios. You would need to find an investment with a fixed long-term return in order to see this see this in action. Unfortunately, most investments fluctuate: they go up and down. What should be taken away is start early, and invest often in order to see real growth.

5. Spend 3 Months Salary on Engagement Ring

Who came up with this ridiculous rule you may ask? A DIAMOND COMPANY! De Beers came up with this gem (pun intended) in the 1930’s during the Great Depression. 

• Pro: Not much to say here. It makes no sense from a consumer standpoint, but it definitely gives you some goal to shoot for when shopping.
• Con: If you make a pretty decent wage, I see no real benefit to actually following this rule. Fortunately, I don’t actually see the 3 month salary rule being followed too much these days. Spend what you’re most comfortable with in the end.

These are just a few of the rules of thumb that you will see and hear out there. When looking at any mass-marketed financial advice (i.e. the internet), consider the question “does this fit my situation?” More often than not, most of these “rules of thumb” won’t even apply to you. We take a comprehensive approach to financial planning where we take the time to understand your individual circumstances so that we can assist you in your planning. Start planning smart, and stop being the government’s personal piggy bank.