10 misleading financial rules of thumb
If you have total faith in some of these oft-repeated statements, you may also believe that it's bad luck to take an old broom with you when moving to a new house.
This post comes from Len Penzo at partner blog Len Penzo dot Com.
I know. I don't buy it either.
Still, let's assume these folks know what they're talking about; what happens if that first flower is found on Friday the 13th? Is the wealth omen officially null and void? Can somebody take an action item and get back to me on that?
Of course, I'd expect such confusion from an old wives' tale masquerading as a fact.
Last year I presented 10 misleading financial rules of thumb, an overview of popular bromides that are essentially just gussied-up old wives' tales.
Yes, I realize not all financial rules of thumb are completely bogus, but some are more dubious than others, usually because they tend to oversimplify and make general assumptions that are intended to work for "the average person." As such, they should always be taken with a generous serving of salt.
Here are a few more examples to help drive the point home:
1. Your emergency fund should have three months' worth of expenses.
If you buy this, you may also believe: You can determine how many children you'll have by cutting an apple in half and counting the seeds inside.
Reality check: While three months of expenses may be good for some folks, that may be far too little backup if, for instance, you lose your job -- especially in tough economic climates where it may take many months to find a new job.
2. Never refinance a fixed-rate mortgage unless you can cut your existing rate by at least one percentage point.
If you buy this, you may also believe: You'll have bad luck if you don't pinch your nose immediately after seeing an ambulance.
Reality check: If you're carrying a relatively small balance on your fixed-rate mortgage, that's probably true. But no-cost refinancings may make it worthwhile even if the spread is less than one percentage point.
3. Buying a car is always cheaper than leasing.
If you buy this, you may also believe: It's bad luck to close a pocket knife unless you were the one who opened it.
Reality check: While buying is cheaper if you plan on keeping your car until the wheels fall off, folks who absolutely positively insist on getting a new car as soon as the old one in the garage is paid off may actually be better off leasing.
4. It's smarter to pay off your credit cards with the lowest balances first.
If you buy this, you may also believe: Three seagulls flying directly overhead means death isn't far away. (Odds are, another unpleasant fate isn't far away.)
Reality check: While the so-called "snowball method" of paying the lower-balance card first and then working on up -- without regard to interest rates -- may be psychologically effective, it's not smart financially. You'll get more bang for your buck by paying off credit cards with the highest interest rates first. Post continues below.
5. To get the best deals, always buy the largest-sized packages, or buy in bulk.
If you buy this, you may also believe: Those who sing before 7 will cry before 11.
Reality check: More often than not, that is true. However, Consumer Reports found that larger packages were more expensive about 25% of the time -- so always check per-unit costs. And those bulk purchases may actually end up costing you more if you fail to use them all before their expiration date.
6. Save 10% of your income annually.
If you buy this, you may also believe: It's bad luck to say "pig" while fishing at sea.
Reality check: While 10% is a noble goal, the right amount to save depends on a lot of factors. For example, while 10% is probably a good figure for those in their 20s, it may not be enough for those who started saving later in life. That figure also depends on your returns on investment. Besides, if you can afford to save more, you should do so.
7. When planning for retirement, a $1 million nest egg is a reasonable goal.
If you buy this, you may also believe: If you wear new clothes on Easter, you'll have good luck throughout the year.
Reality check: Reasonable for whom? For many folks, especially those who live a modest lifestyle and plan to retire relatively late in life, $1 million may be overkill. Instead of striving to reach some random benchmark, your retirement goal should be based upon your anticipated monthly expenses.
8. Buying a home will keep your tax bills low.
If you buy this, you may also believe: It's bad luck to take an old broom with you when moving to a new house.
Reality check: While this may be true in the short term, as a mortgage is paid down, the associated income-tax deductions for mortgage interest diminish over time. And as the standard deduction increases over time, those tax benefits are mitigated even further.
9. Over the long term, homeownership is a terrific investment.
If you buy this, you may also believe: An itchy nose is a sign someone is coming to see you. If it's the right side, the visitor will be female; the left side, male.
Reality check: A lot depends on when you enter -- and leave -- the market. According to The Washington Post, between 1975 and 2008, homes appreciated an average of only 1% after inflation; T-bills earned an inflation-adjusted return of well over twice that much in the same period.
10. An engagement ring should cost two months' salary.
If you buy this, you may also believe: If you knit your fiancé a pair of socks, he'll walk away from you.
Reality check: Relax, guys, the two-month salary bromide is solely based upon a very successful marketing campaign by the De Beers diamond company. The size of an engagement ring should depend only on what you can reasonably afford -- not your salary. Sheesh. Talk about a ridiculous proposal.
More on Len Penzo dot Com and MSN Money:
#4 Snowball Method for paying off debt.
True. Financially, it may be smarter to pay off 'highest interest rates first'; but there is MUCH to be said for paying 'something' off just to get the momentum rolling. And, of course, this all depends on how much debt we're talking about: is it a couple of credit cards and a auto loan, or is it 5 or 6 cards, two vehicles, etc.
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