We play a lot of board games in our family. We tend to find games that have a bit of interaction between the players but aren’t too zero-sum competitive, as our older kids are ten and eight.
We often tell them that these games were all created by people with rules created by people. In life, we deal with immutable laws like those of physics.
We also explain that their behavior, especially when it comes to sportsmanship and kindness, are more important in the infinite game of life and exist beyond the finite game they are playing.
Sometimes, there are conventions and “rules of thumb” that arise out of the written rules.
For example, you should always buy the orange properties in Monopoly if you can. You always build the maximum number of houses on monopolies and avoid upgrading to hotels (there is a finite number of houses, when you buy them then someone else can’t).
These rules of thumb exist because of the rules. In Monopoly, the rules don’t change. As a result, the rules of thumb don’t change. If you changed the rules, then the rules of thumb would change. Add a third die and now those orange properties aren’t as attractive. Infinite houses and hotels would mean you should upgrade to hotels.
In real life, the underlying rules change all the time.
I like to tell my kids – immutable laws of physics don’t change but the rules governing humans and human interaction change all the time.
It doesn’t take a genius to realize that the rules of thumb for money that used to work, ten, twenty or thirty years ago often no longer apply.
Let’s talk about some of them and why they’re terrible:
Table of Contents
- Why Rules of Thumb Are Bad
- 1. You Must Own Your Home
- 2. You Must Go To College
- 3. You Should Pay for Your Kid’s Education
- 4. Spend 2x+ your salary on an engagement ring
- 5. Save X Months of Expenses in an Emergency Fund
- 6. You Should… [Insert Milestone] by [Age]
Why Rules of Thumb Are Bad
When you rely on rules of thumb, you do so out of convenience and laziness. It’s how people get caught unprepared when situations change and then claim “how was I supposed to know???”
That’s the first major reason why rules of thumb are bad – they imply that money rules are like physics – they do not change.
But money rules change all the time! Not only do they change all the time, they also change from person to person. From year to year.
The pandemic taught us a lot about the nature of work. Even today, in the middle of 2022, many industries are finding it difficult to find workers. That’s because the rules have changed.
There are now many ways that someone can earn money on the internet. This reduces the pool of applicants for minimum wage jobs. In 1980, the options for a high schooler looking to earn money were limited and most of them were probably at the local mall. When was the last time you went to the mall?
Today, in 2022, you’re more likely to see them building a following on TikTok, Instagram, or YouTube. Only one in a million will becomes Mr. Beast, a second one will sell millions in NFT art, and the rest won’t (though some will make a little extra cash)… but you won’t see them folding shirts at the Gap or running a cash register in the food court. There’s no upside in retail.
Second, a rule of thumb implies a degree of universality – that they apply to everyone everywhere. When you think about it in those terms, it’s obvious that they can’t be good because how could a single rule apply in all cases?
Even if you believe rules of thumbs are starting points, that creates a situation where the rule is an anchor. And that itself can cause you make the wrong decision because anchoring is a very dangerous bias.
Third, and finally, sometimes rules of thumb focus on the wrong thing entirely. The first rule we break apart is that you should buy a home and while there are many reasons to buy a home, most often people focus on it being a good investment. Not only is it not a good investment but that shouldn’t even be in the top three reasons why you buy a home.
I think rules of thumb are terrible and I hope I can help you understand why.
Let’s dive into some of these common rules:
1. You Must Own Your Home
There are many reasons why you might want to own a home. We own our home and we love it.
But the idea that everyone must own a home or that a home is a great investment are wrong.
Two points to show why this is insanity:
- Home appreciation barely beats inflation
- The median net worth of someone over 65 is $170,516. When you exclude equity in own home, it drops to $27,322. We may have too much home equity.
It barely beats inflation
If you look at historical home values, which is collected by the United States Census (data), the median home value across the United States was $93,400 in 1980 (inflation adjusted to 2010). In 2010, it was $119,600.
That means over the course of 30 years, the price appreciated a mere 0.827% per year.
This is national data and there are regional differences – which is even more proof it’s bad advice for everyone to buy a home everywhere. If you owned a home in an area that saw all of its major employers shut down or leave, you’re screwed. If you owned a home in an area with a growing population because of an influx of employers, you’re a winner.
But to say everyone needs to own their home is not good advice.
It’s forced savings
A big percentage of most American’s net worth is in home equity. Perhaps too much.
A house is often a good investment not because of the returns but because it’s forced investment. The money you pay towards your house you can’t recoup until you sell or refinance. It’s like a big tax refund check – it’s bad money management unless you are not so good at managing your money. Then the forced savings is better because it’s better than not saving whatsoever.
A 401(k) is effective because there are a ton of incentives to contribute and penalties if you withdraw money early. It’s also forced savings… but it has a better rate of return over several decades because you’re invested in the stock market.
My top 3 reasons for buying a home
Remember how earlier I said appreciation wouldn’t even be in my top three reasons?
Well, if you google “reasons to buy a home,” you’ll get a lot of lists about tax deductions, interest rates, appreciation, etc. While all find and dandy, those aren’t the first three I think you should think about.
Those are (briefly):
- You intend to live there for a long time (10+ years)– this secures predictability in your housing situation and costs and puts you in control, move any more frequently and switching costs become a burden (unless employers pay for them!).
- You love the home itself – you can also do whatever you want with it (HOAs notwithstanding I suppose), your home is your domain and you are the ruler.
- You love the neighborhood – Homes are nice but neighborhoods are hugely important too, love thy neighbor and the area and you’ll be happy. Happy trumps how much you “make” on the home.
2. You Must Go To College
College is great. But college can also be very expensive and it is not for everyone.
When I was younger, I thought that everyone went to college and that college was the automatic next step. For some, it is and should be. If you want to be a doctor, you need to go to college. Then medical school. Then a residency. I’d like my medical professionals to follow that track and I bet you do too.
But not everyone wants to become a doctor. Or an engineer. Or something where additional schooling is the next step.
And that is OK!
I recently met a Master Electrician who worked full time and taught classes at night out of a desire to give back (rather than a financial need). He didn’t go to college. He got his start by helping out another “electrician.” He learned the ropes as an assistant and while it wasn’t the most kosher of arrangements (the other “electrician” was not licensed either), he learned a tremendous amount on the job.
He would eventually move to another company, learn about licenses and certifications, and got himself properly licensed and certified in a variety of specialty areas. If he had gone to college, it would’ve been a complete waste of his time and money.
When we graduate high school, we don’t always know what we want to do. College is a very expensive place to find out.
This is something I’ve come to realize more and more as I get older and watch our kids grow up. There are many paths in life and no path is “better” or “more correct” than another.
3. You Should Pay for Your Kid’s Education
If you are sitting on a pile of money you can’t use (nice problem to have!), it makes more sense that you might want to fund their education. You love your kids. You have the funds. Why not pay for it?
It also makes sense if you decide you don’t want to do that because you want them to value their education more because they paid for it. Student loans or not, there’s a bit of responsibility there and perhaps you wish to impart that on them (you can always pay off the loans after the fact, if you so choose).
That being said, the reality is that student loans are expensive and you can only live, and work, so long. If you don’t have the means and it would be a stretch, perhaps it’s better that your kids pay their own way, learn the value of money the hard way, and make decisions with skin in the game.
You want to make sure that your retirement is secure before you even consider paying for their college.
After graduation, they are entering their early and prime working years. You are likely entering your sunset earning years. We want to make sacrifices for our kids… but this is an unnecessary one.
Finally, struggle is always good for human beings. Having them pay their own way is an important lesson in life.
4. Spend 2x+ your salary on an engagement ring
It started as marketing and now continues as insanity.
I use the engagement ring as an example for any rules of thumb around spending because it’s one of the most widely known – you should be spending a multiple of your salary on an engagement ring.
I know the heading doesn’t say how much. It doesn’t even say two times “what” – a month salary? Before or after taxes? Or maybe you hear 6 times a month’s salary?
It’s because it doesn’t matter – the rule of thumb is bullshit.
Much like helping your kids for college, if you have the funds and the desire, go for it. It’s your money and your happiness, if it makes you happy to spend 2x on an engagement ring then spend 2x. Or 4x. No judgment here.
If, however, you don’t have the funds… please don’t spend 2x. Spend what you can afford or save it up. Financing an engagement ring is always an option but high interest consumer debt is a huge relationship killer.
Same goes for the wedding. You only need a handful of things for a successful wedding – family, friends, music, and an open bar. Don’t break the bank for a party, even if it’s a really really special one.
Also, never listen to any rules of thumb around spending, unless it’s trying to get you to spend less.
5. Save X Months of Expenses in an Emergency Fund
An emergency fund is a good thing. And you want to save a multiple of your monthly expenses but any advice that picks a static number, whether it’s 6 months or 18 months, ignores your specific needs and the broader economic environment.
While you want to have an emergency fund, the mistake of this rule of thumb is::
- You pick the multiple based on whatever the advisor is suggesting, not your situation
- You don’t adjust your emergency fund as your risk (or the environment) changes
For example, most experts suggest that you save anywhere from 6 months to 12 months of expenses into an emergency fund. That’s going to be great for most people because if you are not super concerned about your job, then 6-12 months may be good.
During periods of economic strength, people are unemployed for shorter periods of time. During times of economic stress, they are unemployed for much longer. The U.S. Bureau of Labor Statistics keep tracks of this information (unemployed persons by duration of unemployment) and the median moves quite a bit. In the 1st Quarter of 2019, the median duration was 9.3 weeks (2+ months). During the 4th Quarter of 2020, it was 18.9 weeks (4+ months). It’s since come back down to 9.1 weeks in the 1st Quarter of 2022 but you can see how it changes quite a bit.
If you sense we are entering a period of economic stress, you should adjust your emergency fund higher because your risk of job loss and extended unemployment go up.
This is also true if your personal situation changes in other areas. If you know your car is on its last legs or due for a major repair, you’ll want to bolster your fund to be able to pay for it when that time comes.
Likewise, if you risks lessen, you can start shifting some of that money into other areas.
6. You Should… [Insert Milestone] by [Age]
How much money should you have saved by 25? 35? 65?
We often look to benchmarks as rules of thumb for where we should be by when.
The answer is – it doesn’t matter. We have a tendency to look towards others whenever we aren’t sure where we should be in this moment. That’s how benchmarks are set. The government collects a lot of data and makes it available through a variety of departments – if there’s a statistic you want, chances are you’ll find it.
The Census shares the average net worth of Americans and you can find out how much people have saved in each age category. You could also use it to see how well you are doing as compared to your age group. Unfortunately, it’s only based on age and will ignore every other factor! It doesn’t consider your situation, your history, and your unique collection of challenges and advantages.
If you look at averages as a rule of thumb for your progress, you’ll either be uselessly overconfident because you’re “ahead” or unnecessarily down on yourself for being “behind.”
You should be comparing your progress to yourself – how are you doing compared to five years ago? Ten years ago? And a single number is not a good measure. We’d like to believe we make progress each year but if you saved your money and invested it, that balance will change based on the stock market. You have no control over that, up or down.
In fact, I’ve personally enjoyed monthly changes in our net worth that have been greater than what I’ve earned in some years (up and down).
Benchmarks are convenient but ultimately not particularly useful at an individual level.
These are just a few examples of some rules of thumb that really need to be adjusted for your reality.
Things change and people’s advice usually doesn’t keep up – so the next time someone says “you should…” – think twice. 🙂
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Christopher Howes says
A dividend payment from a Company stock is a “return OF your capital and not a “return On your capital ? Be great to have your thoughts on this . Cheers
Jim Wang says
A dividend is just a payment from the company to its shareholders. Whenever cash leaves a company, the value of the company goes down by that amount since that cash was on the books and included in its value. That’s why when a stock trading at $10 per share pays out a dividend of $1 per share, the price of the stock goes to $9.
The distinction of “return OF your capital” or “return ON your capital” is a tax one. Some companies classify some dividends as a return OF your capital, on which you owe no taxes. Some companies classify some dividends as a return ON your capital, which is subject to tax. MLPs are an example of a company that often returns capital – they have to follow special rules for this ability.
I hope that helps.
Outstanding article on those 6 rules. I had a client who told me “I know the rule about emergency funds and that I know you will tell me about them. I am ready to lock and load. Let’s get this retirement fund savings going (outside his 401k)”.
Jim Wang says
Thanks Stewart and your client sounds like he or she knew what they wanted!
Ron Mote says
Great article Jim. Finally, some ‘common sense’ in day-to-day financial decisions! Keep up the good work.
Jim Wang says
Thanks Ron! I’m glad it resonated!
Hi Mr. Jim Wang, LOVE your newsletter. I was made aware of and purchased I bonds by you. Thank you! Would love an article for what to do with home equity, retired and over 70, planning to die at home, no kids to leave it to. I feel as though there is lots of $$ there to spend but afraid to spend it. Your advise? Loyal reader janice native Floridian. ( purchased home for $45,000 in 1984, is worth $500,000 in today’s market)
Jim Wang says
Hmmm this is a tricky question because I don’t know your full financial situation. If you have no other funds, you could tap into home equity and access it that way?