10 More Old Wives’ Tales Masquerading As Financial Rules of Thumb

There are people out there who swear that if you’re lucky enough to see the first flower of springtime on a Friday, it’s a sign of impending wealth.

I know. I don’t buy it either.

Still, let’s assume these folks know what they’re talking about; what happens if that first flower is found on Friday the 13th? Is the wealth omen officially null and void?

Can somebody take an action item and get back to me on that?

Of course, I’d expect such confusion from an old wives’ tale masquerading as a fact.

Beware of Financial Rules of Thumb

Last year I presented my initial list of 10 misleading financial rules of thumb, an overview of popular bromides that are essentially just gussied-up old wives’ tales.

Yes, I realize not all financial rules of thumb are completely bogus, but some are more dubious than others; usually because they tend to over-simplify and make general assumptions that are intended to work for “the average person.” As such, they should always be taken with a generous serving of salt.

Here are a few more examples to help drive the point home:

1. Your emergency fund should have three months worth of expenses.

If You Buy This You May Also Believe: You can determine how many children you’ll have by cutting an apple in half and counting the seeds inside.
Reality Check: While three months expenses may be good for some folks, that may be far too little backup if, for instance, you lose your job. Especially in tough economic climates where it may take many months to find a new job.

2. Never refinance a fixed-rate mortgage unless you can cut your existing rate by at least one percent.

If You Buy This You May Also Believe: You’ll have bad luck if you don’t pinch your nose immediately after seeing an ambulance.
Reality Check: If you’re carrying a relatively small balance on your fixed-rate mortgage, that’s probably true. But no-cost refinancings may make it worth while even if the spread is less than one percent.

3. Buying a car is always cheaper than leasing.

If You Buy This You May Also Believe: It’s bad luck to close a pocket knife unless you were the one who opened it.
Reality Check: While buying is cheaper if you plan on keeping your car until the wheels fall off, folks who absolutely positively insist on getting a new car as soon as the old one in the garage is paid off may actually be better off leasing.

4. It’s smarter to pay off your credit cards with the lowest balances first.

If You Buy This You May Also Believe: Three seagulls flying directly overhead means death isn’t far away. (Odds are another unpleasant fate isn’t far away either.)
Reality Check: While the so-called “snowball method” of paying the lower-balance card first and then working on up — without regard to interest rates — may be psychologically effective, it’s not smart financially. You’ll get more bang for your buck by paying off credit cards with the highest interest rates first.

5. To get the best deals, always buy the largest-sized packages, or buy in bulk.

If You Buy This You May Also Believe: Those who sing before seven will cry before 11.
Reality Check: More often than not, that is true. However, Consumer Reports found that larger packages were more expensive about 25 percent of the time — so always check per unit costs. And those bulk purchases may actually end up costing you more too if you fail to use them all before their expiration date.

6. Save 10 percent of your income annually.

If You Buy This You May Also Believe: It’s bad luck to say “pig” while fishing at sea.
Reality Check: While 10 percent is a noble goal, the right amount to save depends on a lot of factors. For example, while 10 percent is probably a good figure for someone in their 20s, it may not be enough for those who started saving later in life. That figure also depends on your returns on investment. Besides, if you can afford to save more, you should do so.

7. When planning for retirement, a $1 million nest egg is a reasonable goal.

If You Buy This You May Also Believe: If you wear new clothes on Easter, you’ll have good luck throughout the year.
Reality Check: Reasonable for whom? For many folks, especially those who live a modest lifestyle and plan to retire relatively late in life, $1 million may be overkill. Instead of striving to reach some random benchmark, your retirement goal should be based upon your anticipated monthly expenses.

8. Buying a home will keep your tax bills low.

If You Buy This You May Also Believe: It’s bad luck to take an old broom with you when moving to a new house.
Reality Check: While this may be true in the short term, as a mortgage is paid down, the associated income tax deductions for mortgage interest diminish over time. And as the standard deduction increases with each passing year, those tax benefits are mitigated even further.

9. Over the long term, home ownership is a terrific investment.

If You Buy This You May Also Believe: An itchy nose is a sign someone is coming to see you. If it’s the right side, the visitor will be female; the left side, male.
Reality Check: A lot depends on when you enter — and leave — the market. According to the Washington Post, between 1975 and 2008 homes appreciated an average of only 1 percent after inflation; T-bills earned an inflation-adjusted return of well over twice that much over the same period.

10. An engagement ring should cost two months’ salary.

If You Buy This You May Also Believe: If you knit your fiance a pair of socks, he’ll walk away from you.
Reality Check: Relax, guys; the two-month salary bromide is solely based upon a very successful marketing campaign by the De Beers diamond company. The size of an engagement ring should only depend on what you can reasonably afford — not your salary. Sheesh. Talk about a ridiculous proposal.

Photo Credit: Phil and Pam Gradwell

24 comments to 10 More Old Wives’ Tales Masquerading As Financial Rules of Thumb

  • tracee

    great article!!!! (but i still <3 the snowball method!)

    • Len Penzo

      If you’re comfy using the snowball method, tracee, and it’s the only way that credit card debt would ever get paid down, who am I to argue? :-)

  • I love your examples. I certainly think 3 months emergency fund is too little too. I also think it doesn’t have to be in liquid cash. It could be tied up in other things (like Roth IRAs or bonds, etc). I’m a big fan of dual purpose investments.

    • Len Penzo

      Although I don’t do it, I know several folks who use a Roth IRA as their de facto emergency savings account. Personally, I like having a separate dedicated emergency fund, even though I could probably make my emergency fund money work a little harder if it were in a Roth.

  • Buying a home may keep your tax bills low at the inception of the loan, but people forget that a deductible expense still means that you’ve got to spend the money in the first place. The tax benefit is good, but if you can’t afford to make the payments and continue to fund a retirement plan or meet other monthly expenses then it’s still not a good move.

    Reminds me of the old Seinfeld episode where Kramer talks about a write-off, not realizing what a write-off means.

  • DC

    Speaking of rules of thumb, one I’ve heard is, the percent of your investments in stock should be approximately 100-(your age). If you are 25, have about 75% of your portfolio in stocks, at age 50 it should be down to 50% stock, etc. What do you think of that one?

    • Len Penzo

      Hey, you’re a great straight man. I covered that one in my first edition of this post a year ago, DC!

      http://lenpenzo.com/blog/id1499-financial-rules-of-thumb-that-are-really-old-wives-tales.html

      Like most rules of thumb, it depends. The folks at CNN money think that is not aggressive enough. I’m going to take the cop out answer and say “it depends” on your particular situation. For example, if I had a healthy nest egg already built up at, say, age 60 — I’m not sure I would want to still have 40 (or 50 or 60, if I follow CNNs advice) percent of my portfolio in the stock market. Then again, if I was way behind, I’d most likely have to be more aggressive.

  • and where would you place this on your list of old wive’s tales?
    Obama’a budget

  • We spent our tax refund on my engagement ring years ago. It is nothing fancy but dear to my heart. Who cares that it was not expensive? Happiness in marriage is not determined by the size of your ring.

  • Good stuff! And you say I march to a different drummer.

  • Spedie

    Well, it kinda depends on your break even point and where you are in life. For one:

    1. A three month emergency fund is not enough. I put 18 months in my “bare bones” EF long ago. I do not follow the “crowd”;

    2. A one point drop in interest..well, I just refinance from a 15 year, 5.5 percent fixed, with 12 yrs left, to a 10 year, 3.25% percent loan, with a savings of $160 per month. I also shopped for the lowest refi costs, to make my break even point as short as possible…but I admit, I am a weirdo. It was good for me.

    The rest of this article is not good for me, but I am a weird nut…

    Kinda like having a credit card is a good thing! Not my bag.

    Spedie

  • I have always heard minimum 6 months worth in emergency fund. Three months is too little.

    • Len Penzo

      I agree. Right now, like Spedie, I’ve got about 18 months cash reserves on hand. When times were booming, 3 months may have been okay. Certainly not today.

  • HA! I totally agree about the engagement ring thing, and I’m a girl. It’s just so not necessary. Some other women may want a ring that expensive, but being a personal finance geek, I think it’s just too much. I’d much rather spend the money on a rocking honeymoon anyhow! :)

  • I never did understand the two-months salary thing…if my husband had bought my engagement ring based on his college student transit system earnings , I’d have one tiny diamond! (We got engaged before our senior year of college). That rule of thumb puts unnecessary pressure on everyone. I say buy her the ring that will get her to say yes! :)

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