10 Old Wives’ Tales Masquerading As Financial Rules of Thumb

It’s been said that if the palm of your right hand itches, you’ll soon be coming into money. On the other hand (seriously, no pun intended), it’s also been said that if your left palm itches you’ll soon be paying out money.

Don’t laugh. There are folks out there who actually believe this stuff.

What is funny though is if you do an internet search, you’ll find there is no consensus at all regarding which palm is which; some sites proclaim it is actually vice versa.

Of course, I’d expect such confusion emanating from what is essentially nothing more than an old wives’ tale.

Beware of Financial Rules of Thumb

If you ask me, a surprisingly large number of other “financial rules of thumb” are actually nothing more than gussied-up old wives’ tales too. In fact, they’re almost as crazy as those itchy palm notions.

That’s not to say that all financial rules of thumb are completely bogus, but some are more dubious than others because they are often based on misguided conventional wisdom or generalized ratios that are intended to work for the average person. As such, they should always be taken with a generous serving of salt. To prove it, here are a few examples:

1. Red cars are more expensive to insure.

If You Buy This You May Also Believe: If three people are photographed together, the one in the middle will die first.
Reality Check: How much you pay for your insurance has absolutely nothing to do with the color of your car. However, it does depend on the car you drive, your age, and your driving record.

2. Buying a home is always better than renting.

If You Buy This You May Also Believe: It’s bad luck to leave shoes upside down.
Reality Check: During the last real estate run-up, this mantra was repeated ad nauseum. The truth is, sometimes paying rent may make a lot of sense. In exchange for that rent payment, you’re getting a place to live without all the commitment and additional costs that come with owning a home. For a lot of people, the added responsibility is more hassle than it’s worth.

3. Avoid adjustable rate mortgages like the plague.

If You Buy This You May Also Believe: If you swallow a watermelon seed, a watermelon will grow in your stomach.
Reality Check: If you are absolutely positive that you will only be living in your house for a short period of time, an adjustable rate mortgage (ARM) may save you a significant amount of money — even when rates are rising. This is especially true for hybrid ARMs where the loan’s interest rate may remain fixed for, say, three or five years before readjusting.

4. When planning for retirement, assume annual stock market returns of 8 percent.

If You Buy This You May Also Believe: A cow lifting its tail is a sure sign that rain is coming. (Well, it’s a sure sign something’s coming.)
Reality Check: Between 1981 and 1998, when the stock market was averaging annual returns of almost 13 percent, this figure seemed conservative. Since then, the stock market has seen the bursting of dot com bubble, followed by a second crash in 2008. According to some experts, the stock market can now be expected to return only 4.5 percent annually, based upon current valuations.

5. To determine the percentage of stocks you should have in your portfolio, subtract your age from 100.

If You Buy This You May Also Believe: Placing a bed facing north and south brings misfortune.
Reality Check: According to CNN money, because of longer life expectancies, this number may not be aggressive enough. Instead they recommend subtracting your age from 110, or even 120.

6. Never buy a house that costs more than three times your annual income.

If You Buy This You May Also Believe: Any ship that sails on Friday will have bad luck.
Reality Check: When I bought my last house in 1997, I paid roughly four times my annual income. It was tough for awhile, but not impossible by any stretch. A broader, but much better, benchmark to follow is to make sure the ratio of all of your monthly debt payments to your gross monthly income does not exceed 36 percent.

7. You should close any credit accounts you no longer use.

If You Buy This You May Also Believe: Dreaming of a lizard is a sure sign that you have a secret enemy.
Reality Check: Credit card companies see long-held accounts — especially those lacking negative reports — as proof of credit responsibility. Because a portion of your credit score is determined by your borrowing history, as well as the ratio between the balances on those cards and your total available credit, it’s often wiser to keep your unused credit accounts open.

8. When planning for retirement, anticipate replacing 80 percent of your pre-retirement income.

If You Buy This You May Also Believe: The spouse who falls asleep first on their wedding day will also be the first to die.
Reality Check: The problem with this rule of thumb is that it assumes expenses will stay the same in retirement, when for most people nothing could be further from the truth. For example, kids move away, people may pay off their mortgage and/or downsize to a smaller home. The truth is, for many reasons many people will spend far less in retirement than they do in their working years.

9. To quickly figure a server’s tip, double the first digit of the bill’s total. If the bill is $100 or more, double the first two digits.

If You Buy This You May Also Believe: If you say goodbye to a friend on a bridge, you’ll never see each other again.
Reality Check: The standard tip for good restaurant service has been 15 percent for decades. Well, that is until tip inflation once again reared its ugly head. If you’re not careful, following this rule could result in an overly generous tip.

10. Your minimum net worth at any given age should be your age multiplied by your pre-tax annual income, with the result divided by 10.

If You Buy This You May Also Believe: Salty soup is a sign that the cook is in love.
Reality Check: Never mind that this formula has many flaws. Net worth is just a snapshot in time that serves very little purpose, unless you plan on liquidating all your assets. In fact, in the grand scheme of things, the annual change in one’s net worth is a much more important indicator of financial health. Yes, folks, even more important than an itchy palm.

Comments

  1. 2

    says

    So does CNN think I will live to be 120? That will NOT be a pretty sight, I guarantee it.

    If we need 80 percent of our current income to live in retirement, then I better plan on retiring at 110…

    I used to think buying a house was a great investment. Then I bought a house and realized taxes and repairs will eat away at your savings, not to mention the falling house prices. I now tell people to consider renting until they can find the deal of the century and to not rush.

  2. 3

    Candy says

    Too funny! I hate to admit this, but I used to think #1 was true and I figured #3 was good advice until now. But your explanation makes sense. I’ve heard of all the other ones too except #9 and #10.

  3. 4

    says

    “Salty soup is a sign that the cook is in love.”

    Now that’s just nasty, in many ways! I thought this was a family friendly blog ;)

    However there was this one time I ate at Chili’s and everything that was served tasted like it came off of a salt lick. There’s no telling what the “mood” in the kitchen was….

    Speaking of restaurants, I shall now read your tip inflation link as as referenced in #9.

  4. 5

    says

    On #6, I do think there needs to be a CONSERVATIVE rule of thumb to keep people from buying more house than they can afford. Overbuying–not buying itself–is what’s caused the housing crash.

    My own thought is buy only if you have a real intention and a solid, workable plan for paying off the mortgage early (like less than 15 years). Not only may that be needed to stay ahead of future price declines, but it seems that we’ve gone back to the good, old days when the primary benefit of owning a home was working toward the day when you’d own it free and clear.

    There haven’t been too many mortgage burning parties in recent years, but maybe that’s what we need to go back to (commentor feels a post idea blooming here!).

    The days of rapid price run ups may be behind us, and we need a whole new way of looking at home buying. It’s no longer a can’t miss/get rich quick (maybe) venture, and that changes everything.

  5. 6

    says

    When I bought my house in 1996, I really wanted a fixed mortgage, but I could only qualify for an adjustable. It turned out to be very lucky, because the interest rate quickly dropped from 7% and has been much lower for the entire term of the loan. I never had to refinance.

    Right now, with interest rates so low and certain to go up, I would avoid an adjustable mortgage like the plague.

  6. 7

    says

    Good points! A lot of these financial rules are out of date (especially #1 and #5).

    On #3, I understand the advice here, especially for the majority of people (unless you are planning to move in X years…). I do have to admit, I was tempted on refinancing to an ARM before the last few years of my house mortgage was paid off.

    Anyway, each point cracked me up as I was reading them! I had no idea old wives tales could be so much fun!!!

  7. 8

    says

    These Rules of Thumbs leave out things like additional facts! For example, red cars are expensive to insure, if it is a Ferrari. Then again, a Ferrari is expensive to insure!

  8. 9

    says

    Good list! I agree with your assessment of rule #6, it’s almost impossible to buy a house for 2-3 times your income these days but as long as your personal debt load is under control you will be fine.

    As for #5, I would go even further to say that this rule is completely bogus. Especially for a dividend investor, why would you switch to a fixed income in retirement when you could be making growing dividend income each year without even eating into your capital?

  9. 10

    says

    I’ve been touting rule #6 myself- the 3x’s your income thing. Maybe that’s why I’ve been stressing out about home ownership (especially in the LA area – there are hardly any homes within this range for me!) Although, I do think it’s better to be on the safe side and not push too far past that figure.

    As for the bed facing north/south – I thought it was good luck to have your head pointing north. Drats, I’ve arranged my bedroom in precisely this fashion. ;)

  10. 11

    says

    All right, this is one of my favorite posts of the new year thus far. And don’t ask my why the lizard comment got me to laugh out loud…because I can’t answer that question either.

    And oh yeah…good points. I agree on 9 of them, on the fence on the 3x income rule for a house. That one might depend on where one lives, so I can’t exactly disagree here.

  11. 12

    says

    Hi Len, I’ve only heard of one of these old wives’ tales before. I guess I’m not that old. ;)

    I have a 10 year old red sedan, so it’s pretty cheap to insure. I wasn’t sure about #7, but I’m glad to hear that my laziness to close accounts is a good thing. I personally believe that most middle class folks have too much invested in stock and should have less, although I realize my view is unpopular. You have a point about ARMs from a math sense, but if people can’t sell their house at the right time they will take a bath. Other than that, I’m in 100% agreement. :)

  12. 13

    says

    Where did you come up with the “If You Buy This You May Also Believe” quotes? I never heard of any of them! Super amusing though.

  13. 14

    says

    @20Something: Just to be cleat, are you talking about the old wives tales? Or the financial, ahem, rules of thumb? :-)
    @Everyday: LOL! I’m scary looking now, Kris. I’d hate to think what I would look like should I be lucky to make it to 120. Your comments remind me that I should have added another financial old wives tale: “Your primary home is an investment.” Oh, how I used to cringe when people were saying that during the last housing run-up! No, folks, it’s a place to live. Period!
    @Candy: No need to be embarrassed. I used to believe a couple of these too.
    @Pineview: Thanks a lot. Until your comment I was a huge fan of soup. Now I’ll never look at it the same way again. Salty or otherwise. LOL
    @Kevin: Re: #6. I think it all depends on where you live. If you live in places like New York City, Los Angeles, or Washington DC it is definitely a wives tale. If you live in Amarillo, Omaha or Rapid City — it’s still valid.
    @Bret: Wow! Talk about great timing! If I was absolutely certain I was going to move before my hybrid ARM reset, I’d still take advantage of one.
    @MoneyReasons: Glad you enjoyed them! That’s also great that you have paid off your mortgage. Congrats!
    @krantcents: True, which is what makes them so dangerous! (A red Yugo is still cheap to insure.)
    @Echo: Glad you liked the list. That makes sense as long as you are smart about picking those dividend payers!
    @LittleHouse: I think 3 times is a bit too conservative in LA, but that’s me. I wouldn’t put too much credence in the north-south thing either, Jennifer!
    @Squirrelers: Wow, what a nice complement! Thank you, Wise Squirrel. :-) Too bad the year is only two weeks old! LOL
    @Jennifer: I hear ya about stocks… I’m really wary of the stock market right now too — still, nobody is going to grow their money as much as they probably need to by simply putting all their earnings in a savings account.
    @Jenna: Let’s see, you can find them on the internet with a simple search. There are tons of sites. Here is a particularly good one:

    http://www.corsinet.com/trivia/scary.html

  14. 15

    says

    #2. A friend of mine working as a broker says you can always make money in real estate as long as you don’t sell it. You have to stay in it for as long as you can. The longer, the better.

    #4. To diversify, buy mutual funds.

    #5. Has worked for many.

    #7. To open or close a credit card account, you credit score gets lowered by at least 75 points.

    #8. Times have changed. There are folks in retirement who are still paying monthly mortgage.

  15. 16

    Mara Alexander says

    I’m new here, and I gotta ask…I’ve read several of your articles so far and liked them very much (even shared one on Facebook).

    In every article, however, your first 2-3 paragraphs are links going to 21st Century auto insurance…the entire paragraph is linked. If you’re doing that one purpose, I gotta say…it’s odd (that was the kindest word that came to mind). If you’re not doing it on purpose, then maybe you might want to look into how it’s happening.

  16. 19

    tommyboy says

    I disagree on #9

    20% is pretty standard fair for good restaurant service (unless it is a very expensive place, then they’ll probably be adding 18% automatically anyway, especially if it’s a big party).

    15% worked when servers were paid closer to the actual minimum wage, but server’s get paid so much less than minimum with today’s economy; An excellent server needs to be rewarded for making your meal enjoyable (by not making mistakes or forgetting to fill drinks!!!).

  17. 20

    hannah says

    I disagree with the take on #7. It is true that you should never close your oldest credit card account.
    However, if you have a bunch of credit cards and only use one, it would be foolish to keep them all open.
    For one thing, identity theft is rampant, and unused cards would be easy to forget to update, check for fraud, not miss new cards being issued, etc.
    For another, if your cards are all around the same age, it isn’t going to hurt to remove a few.
    When my spouse and I got married, multiple life events led to us ending up with four different credit card accounts opened in the same year. Two of those were store cards which don’t help your score as much.
    After we had them paid off – on time, as planned! – I was very happy to close them all. We never planned to use the store ones again, and didn’t want to do business with the other credit card companies.
    Now we have our oldest credit card account, and two others that we regularly use. Our score dived for a month or two after closing the accounts, but has now bounced back and looks great.
    Don’t run your financial life based on a score, but on how to make it work best for YOU, and the good score will follow.

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