Psst. Some financial rules of thumb can’t be trusted.
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.
Then again, what is funny is the lack of consensus regarding which palm is which; some sites proclaim it’s actually vice versa.
Of course, I’d expect such confusion emanating from an old wives’ tale.
Beware of Financial Rules of Thumb
There are many “financial rules of thumb” that are nothing more than gussied-up old wives’ tales too.
That’s not to say that all financial rules of thumb are completely bogus, but some are more dubious than others if only because they’re based upon misguided conventional wisdom or generalized ratios designed for the “average” person. Here are just a few examples:
1. Red cars are more expensive to insure.
If You Buy This You May Also Believe: When 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. It does, however, 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: Sometimes paying rent makes sense. Especially if you’re the type who wants a place to live without the commitment and additional costs that come with home ownership.
3. Avoid adjustable rate mortgages like the plague.
If You Buy This You May Also Believe: Swallowing a watermelon seed will cause a watermelon to grow in your stomach.
Reality Check: If you’re absolutely positive that you’ll 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 several years before readjusting.
4. When planning for retirement, assume annual stock market returns of 8%.
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 is coming.)
Reality Check: This figure seemed conservative between 1981 and 1998, when the stock market was averaging annual returns of almost 13%. Today, that number is a pipe dream for the average person.
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: A bed facing north and south brings misfortune.
Reality Check: Longer life expectancies mean this number is probably not aggressive enough. Many financial advisors now 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 current home in 1997, I paid roughly four times my annual income. It was tough for awhile, but not impossible by any stretch.
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: 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% 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: This assumes expenses we pay in our working years stay constant in retirement — but why? Kids move out, educational expenses wane, and many folks eventually downsize to a smaller home or pay off their mortgage.
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: Saying goodbye to a friend on a bridge means you’ll never see each other again.
Reality Check: The standard tip for good restaurant service has been 15% for decades. Well, that is until tip inflation reared its ugly head.
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: Unless you plan on liquidating all of your assets, net worth is just a snapshot in time that serves very little purpose. In fact, a far better indicator of financial health is your annual change in net worth. Yes, folks — even better than an itchy palm.
Note: If you’re interested in learning about even more old wives’ tales that masquerade as rules of thumb, then check out Part 2 here!
Photo Credit: Phil and Pam Gradwell
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.
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.
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.
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!!!
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?
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. 😉
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.
#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.
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.
Wow… I’ve never heard of half of these, but they’re kinda funny!
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.
“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.
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. 🙂
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.
You can learn some amazing things with a search engine.
This made me laugh this morning. I love the old wives tales! Thanks for including this in your year-end list!
My pleasure, Pam. Comments like yours make my day. 🙂
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!!!).
I tipped more (when I still ate out) at breakfast and lunch, usually $5.00 minimum rather than percentage, knowing the servers (at that time) were being paid about $1.25/hour, and were possibly asked to do kitchen chores instead of serving tipping customers. (I once worked in hotel front offices.)
My dinner tips in the 15% era started at 20%, and went up or down from there. If you wanted a really bad tip, make me wait 20-30 minutes after we have finished our meal to get the check.
And don’t make me go chase down the hostess to get my check because you went out to smoke or went home (it has happened).
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.
On the whole red cars are more expensive to insure. For instance the vast majority of Ferraris are red, and this is an expensive car so insurance statistics pull the cost of insuring red cars higher. Many Corvettes, Lotus, Viper and other expensive sports cars are commonly red. Your average Ford, Chevy, whatever vehicle is generally black, white, gray, silver. Therefore red cars are statistically more expensive to insure, but that is really because of the type of car which tends to be produced in red.
Red was Enzo Ferrari’s favorite color, and in his honor most Ferraris are still produced in red.
I had a college friend who said that as mid-life approached, he went to a dealer and sat in a red sports car. He joked “It came equipped with three speeding tickets.” He didn’t buy it.
This is a wonderful myth busting post! I had a friend who avoided red cars because she believed the myth haha! I had a good laugh at some of your examples. Great post, keep it up!
If the home search/buying tv shows are any indication it seems folks simply buy too much house in many cases. I always went by two rules in buying a home, no more than 3X wages and the monthly mortgage payment no more than rent for a comparable house. Owners better learn some fixit skills unless you like wasting money.
News flash, renters pay for the taxes insurance and maint of where they live, plus profits and there is an eventual appreciation.
This was excellent! Now I am going away to do my breakfast. Then I’ll be back having my breakfast to read other stuff here.