Rules of Thumb are Mostly Dumb

“I’m 53 years old and I don’t see how I am going to accumulate $7 million dollars before I retire.”

“Seven million? Help me understand why that number is your target.”

“Oh I heard it’s what everyone needs to live comfortably in retirement.”

I’ve had this conversation with any number of clients—or close to it. The next thing I say is always something along the lines of “don’t believe it.”

The $7 million figure is a rule of thumb. It might be plenty for the future if you’re in your 50s now and not nearly enough if you’re in your 20s.

But either way, financial rules of thumb are just rough estimates that get so much play, people accept them as truth without factoring in the way they themselves live.

Some get on with the inflows from social security and a modest distribution from retirement accounts just fine and want for nothing. Their satisfaction centers on their lives, family, friends and activities that light them up.

If you’ve heard the $7 million for retirement rule of thumb, you’ve probably heard these “rules” too:

  • Save 10-15% of your income for retirement
  • Have a three-month emergency fund
  • Use a 4% withdrawal assumption in retirement
  • Your living expenses should be less than 50% of your income
  • Your stock allocation should be 100% of your portfolio holdings minus your age
  • Spend 10-15% of your budget on food
  • Refinance your home if you can lower your rate by 1% or more

The ideas here are fine as a rough measure, but they might or might not have any meaning in your life, your circumstances and your values.

Any time you begin making your financial plans with your balance sheet instead of your values, the results are likely to miss the mark. So if your financial planning begins with the adoption of these rules, you are probably working backwards—and potentially in conflict with what you really want out of life.

Yes, it makes good sense to save a good portion of your income for the future, but the amount is dependent on many factors, such as:

  • When you plan on retiring
  • Your life expectancy
  • Where you’re planning to live after you retire, and what it will cost to live there. (Hint: the cost of living in Hawaii is greater than the cost of living in Idaho.)
  • Clarity around what you want out of your years after work.
  • Whether you must leave a financial legacy
  • Whether you would like a simple lifestyle or a lavish one

In other words, you might want to put a whole lot more away if you’re planning an early exit from your career. Or you might be able to put less away if you plan on living simply in a low-cost locale. What you want really matters.

When it comes to portfolio allocation, in these days of meager interest rates on fixed income, we’re seeing an argument for investors of any age keeping as much as 100% of their portfolio in equities, aside from what they need for liquidity purposes.

I am not saying this is right for everyone—then it would be another rule of thumb—but the idea of setting your stock holdings to age is also nutty. Your allocation to equities should reflect your situation, your needs, and your ability to withstand market volatility and the occasional recession.

Another fuzzy rule is the one about how much should be in your emergency fund. Three months? Really? Well, for those in a very stable job or a two-earner household three months might be just perfect.

But what about someone who is self-employed or in a field where job disruptions are common, or someone who relies on their physical condition to earn? I know several trainers at my gym; they get paid based on the number of training sessions. If they go on vacation or are out sick, no paycheck. Would you apply the three-month rule to them? Certainly not!

The right moves and strategies are vital to your financial well-being, but those strategies need to be yours and fit your circumstances, not some general rule that doesn’t apply to you.

Begin with knowing the things that are most important to you and why they are important. Then you can apply strategies that make sense to you. After all, it’s your life, and your actions should reflect your values.