10 Old Wives’ Tales Masquerading As Financial Rules of Thumb

investing_1It’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.

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