Rules of thumb are meant to be broadly applicable, but when handed down as the wisdom of elders they can be very dangerous.

Question the rules

Rules of thumb cannot be implemented without question. Here are some that are worthwhile but nonetheless have flaws.

  1. The 10% rule: Always save 10% of your salary. Doesn’t take into account when you started, what return you will get, and what kind of life you want at the end.
  2. The 50/30/20 rule: 50% of your income goes to necessities, 30% to financial goals and 20% to choices. Depends on your stage of life. The ratios need to be adapted to different stages of life.
  3. The 20/4/10 rule: When buying a vehicle, put down 20% as a deposit, pay it off in 4 years and don’t spend more than 10% on transportation costs. Don’t buy a vehicle you have to finance.
  4. The 20% rule: ‘Put down a minimum of 20% as a deposit on a home’. Depends on your income relative to the cost of the home.
  5. The Six-Month Emergency Fund Rule: ‘Have at least six times your monthly expenses in an emergency fund’
  6. The amount of life insurance you need is five times your annual salary. Depends on the level of other assets and income
  7. ‘100 less your age is the percentage of shares you should have in your portfolio.’ Depends on total assets relative to income required and emotional risk profile.
  8. Here’s one that people in other countries apply and Sydneysiders will laugh at: “The cost of your home should be no more than 2.5 times annual income.” 

My  rules of thumb

I’ve come up with a couple of my own that I use daily.

  1. How much is enough? 20 times your annual expenditure, (assuming you have a maximum 35-year time horizon). Another way of looking at this is double your lifestyle assets — you need twice as much in investments as the value of your home
  2. Changing home. Every time you sell your home and buy another, it costs one year of work. Here’s my theory – the costs of selling a home are 4% stamp duty plus around 2% commission to the agent – all after tax. That’s equivalent to around 10% pre-tax, and for most people, their annual income is around 10% of the value of their home.

Personalise rules of thumb to make them useful

The value in having rules of thumb is that they provide a benchmark that’s easy to remember. And there’s no doubt that having a benchmark influences behaviour. At the same time, for it to be believable, it needs to be personalised. Take the basic rule and tweak it to suit your purposes. Then apply it.