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Four Rules of Thumb In Need of Refreshing

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Thumbs Up!Rules of thumb are great. They teach you a little nugget of wisdom and have been vetted by generations of experience. Don’t swim thirty minutes after eating, don’t mix hard liquor and beer, and don’t date your relatives. Follow those rules of thumb and you’ll live a happy and healthy life.

The same can be said about financial rules of thumb. Don’t spend more than you earn, save 10% of your salary, and always buy a used car. You don’t have to always follow those rules of thumb, but if you want to achieve financial prosperity, it’s best to heed them.

However, over the years, some rules of thumb are in need of a refresher. Times change. A rule that made sense ten or twenty, or even a hundred, years ago may not make sense. Let’s have a look.

Emergency Funds

Your emergency fund should be 6 months worth of expenses. I’ve always argued that your emergency fund should have at least six months and probably at most twelve months. I’ve seen versions of this rule that go as little as three months and as many as eighteen! Ultimately, this is another case where you need to look at your personal situation to help determine how little or how much of an emergency fund you need.

How much you save will also depend on your risk tolerance and how comfortable you feel about your job. If you are very conservative, you might want a larger safety net. If your job situation is tenuous, you might want a larger safety net. In the linked to article above, I discuss the various factors you need to consider, especially during this economic crisis, when deciding how much to save.

Engagement Rings

Spend at least X months of salary on an engagement ring. This is always a fun rule to talk about, especially at my age when a lot of people are getting engaged and married. I’ve heard this rule go from two months to as many as six months. If you really love your wife-to-be, you’ll spend two months (to as many as six months) of salary on an engagement ring. The rule doesn’t specify whether it’s gross salary or after taxes and deductions (how much do you love her? Hmmmmmm???), so you’re left to ponder that question as a homework exercise.

The reality is, the rule is completely bogus and self-serving for diamond salespeople! What if your girlfriend loathes the thought of a blood diamond, one acquired from an area rife with conflict? If you bought her a diamond and spend a mere one month’s salary then you’re a bonehead. If she doesn’t even like diamonds or thinks the idea of spending that much money on one item, regardless of its sentimental reason, is foolish, then you’re wasting money and not listening (it’s up to you to figure out which one is worse).

The rule should be – communicate and then decide what makes sense.

Housing

Spend less than 30% of your gross income on housing. When I was looking out houses, I saw this figure everywhere. It’s a decent rule of thumb but something you need to put through your own filter to see if it makes sense. The best thing you can do to find out how much you can spend is to maintain a budget. You don’t need to track every last purchase down to the penny, but you do need to know how much you’re spending on “other stuff.”

If you really enjoy living someplace and it costs 40% of your gross income, get it if you have the breathing room. Like any purchase, if you want it and it’s a stretch, you’ll need to sacrifice somewhere else to afford it. The tricky thing is that if it’s a mortgage, then you’re on the hook for a long time!

Student Loans

Don’t take out more student loans than what you expect to make in the first year. This rule of thumb puts a reasonable upper limit on how much in student loans you should take out, which is a good thing, but doesn’t paint the whole picture. I like this rule of thumb because your future earning potential should dictate how much you should be spending on a college education, but it fails in the face of a lot of careers.

Let’s take law as an example. First year lawyers don’t get paid that much, relative to the cost of their education, so by that rule of thumb only kids from cash-rich families would ever become lawyers. However, lawyers earn considerably more once they’ve gained more experience and increased their networks.

A better rule would be to calculate how much of a student loan payment you could reasonably afford based on your first year salary. Assume you can afford, at most, 10% of your salary for student loan payments (that’s a rule of thumb I just made up). Work backwards from that to figure out how much of a student loan you can afford to service each year and let that be your limit.

And don’t spend any of that student loan money on anything other than tuition!

Are there any rules of thumb out there that you think need a serious refresher?

(Photo: joeltelling)

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66 Responses to “Four Rules of Thumb In Need of Refreshing”

  1. A couple of refi-related ones:

    - Don’t refinance until you’re in a house for at least a year.

    - Don’t refinance until you can save 1% on the interest rate.

    The first one never really made sense (unless you’re trying to avoid impacts on your credit score, I guess). If the rate drop through the floor a week after you close, LOCK IN.

    The second might have made sense when houses cost less. It still makes some sense in some housing markets. The reality of the situation is this: the larger the balance on your mortgage, the quicker your break-even. If you slice a half point off a 500,000 mortgage, you save nearly $2500 in the first year. If you save a half point off a 100,000 mortgage, you save only $500 in the first year.

    • Jim says:

      Until today, I had never heard of the one-year rule of thumb you mention but it doesn’t seem to make much sense, unless you aren’t allowed to refi (as Richard says). As for the second one, I’ve heard that before and with computers and calculators so widely available, you can do the math to see when it makes sense. :)

  2. Richard says:

    @Kosmo

    From my experience dealing with loans, most have a 1 year hold before you can straight up refinance.

    Also, I’ve seen notes where even a 2% drop in the interest rate would INCREASE THE AMOUNT SPENT over what they already have.

    Everyone focuses on the rate without regards to how the interest is figured or how often pay. Both of those effect how MUCH you pay more than the rate alone.

    @OP

    For a wedding set, I spent half a month’s pay on it. Wife loved it. Mostly because she picked it out. :)

    • Jim says:

      I agree with you on the focus on interest rates, you should always do the math to see how it affects you. If you have only a few years left, it may not make sense.

      As for the wedding set, it’s about getting what she wants, not spending what the salesperson wants! :)

    • That’s a good point – the other side of the coin of my “the larger the balance on your mortgage, the quicker your break-even” – the smaller the balance, the slower the break-even. If you have 10k remaining on your mortgage, it’s going to be really hard to break even on the refi costs.

      I echo Jim’s sentiments. Use a calculator.

      As for not being able to refi until the loan has been held for a year … if there’s a big drop in rates, I’ll jump to another lender if I need to. My particular lender does not have this rule, though – we asked him to watch for a particular rate just a few months after a refi (when rates were crashing) and he had no problem with this.

      • Jim says:

        I don’t see why lenders would care, they get to earn the closing costs all over again (or a portion of them anyway). More profits!

  3. Kathi says:

    I agree with you on engagement rings — that one is really outdated. I’ve always assumed that was from the days when wives didn’t work and she needed to be confident you could take care of her (and maybe have something to hock if you didn’t). I much prefer to see marriage as a partnership, so a discussion of expectations is in order!

  4. Richard says:

    There is a problem with calculators though, they only figure the most basic of figures. If you add in all the different ways loans are figured (included when they re-aromatize), the figures would be different. I’ve actually though I building a calculator that would do this.

    There are also loans, as I mentioned, that even at 2% higher rates, you pay less in interest charges.

    If I ever get it finished, I’ll post a link and let you guys have at it.

    • Yeah, I was referring to fixed rate mortgages, since that’s what I’m familiar with.

      I’d be interested in seeing the loans you are referring to.

      • Also, if you’re handy with Excel, you can build amortization tables pretty easily (5 minutes), and really get into the nuts and bolts to make “point in time” decisions.

      • Richard says:

        The loans I’m referring to are fixed interest, daily amortized, bi-weekly paid loans. Add in the incentives the bank offers for paying bi-weekly and not only does it save money, it also pays off faster.

        Just by paying bi-weekly on it vs. a fixed monthly/yearly amortized loan, shaves about 3 – 7 years off the back end because of how the interest is figured.

        • Andrew says:

          AFAIK, all mortgage interest is calculated the same way. If you make a payment every two weeks instead of every month, you are paying out 1/12 more in payments each year. This, not some unorthodox way of calculating interest, is what makes the payoff period shorter.

          Figure a $500K loan at 5% for 30 years fixed. Your monthly payment would be $2,684.11, or $32,209.30, and it would take you 360 payments (30 years) to pay off the loan.

          Now pay off that same loan with biweekly payments equal to half the monthly payment in the previous example, and you will pay $33,552.71/year, but you will only have to make 656 such payments to pay off the loan, which means you pay it off in about 25 years, 3 months.

          The higher the interest rate, the faster you can pay off the loan with this method. At 10%, you’d pay off the loan in just 21 years. At 0%, it would still take you 27 years, 9 months.

          There’s no magic to it, you’re just paying more, thus reducing the amount of interest due, since interest is based on the amount of principal remaining due, which declines continuously.

          • Richard says:

            Essentially, all interest is figured the same way. However, when it comes to scheduled interest loans (most mortgages), they pre-figure the interest based on an expected payment plan. If they don’t re-figure the interest, then you overpay.

            Paying bi-weekly is great on daily and monthly amoratized notes since the balance is taken into effect for future payments. For yearly and never re-amoratized, after 6 months, you start over paying in interest.

            Things get real crazy when you add in extra payments or extra amounts to your payments, especially in lump sum amounts.

            It does effect how long it takes to pay off, however typically only by several months at most. But that is that much more money coming out of your pocket for no other reason than the lender being lazy/greedy.

    • Jim says:

      Yes that is true, but with a calculator you get a better answer than with a rule of thumb. :)

  5. OK,former mortgage guy here to weigh in on the refi question…

    The most accurate way to determine if a refi is worth doing has little to do with rates, and is a bit more involved. That “1% rule” is probably something dreamed up by mortgage people trying to come up with a foolishly simple guideline to entice people to do something that may not be in their best interest to do.

    So here is the real deal…

    Take the amount of the closing costs paid for the refinance–let’s say $3000, and we’ll call that “X”.

    Next calculate the monthly savings. That’s the difference between your current payment and the proposed one Say your current payment is $1000/mo, and the proposed payment is $950/mo, enabling you to save $50/mo. We’ll call that number “Y”.

    Divide X by Y, or $3000 divided by $50. That gives you 60. 60 is the number of months it will take you to recover the closing costs through lower monthly payments. But we’re not done.

    60 months = five years.

    Question: How long do you intend to stay in the house? Longer than 5 years, continue to the next question; less than five, STOP, you shouldn’t refinance.

    Next qestion: Is there an expected change in your family situation that might see you needing to refinance within five years? For example, an elderly relative coming to live with you that might require an addition to the house, or a child expected to go off to college requiring a cash out refi in the next few years?

    As I said, this is more complicated than a 1% rule, but it’s really the way it needs to be handled, otherwise you risk equity stripping from repeated refi’s, all in the name of a lower rate.

    • One thing to look out for – are you swapping out 23 years remaining on a 30 year mortgage for a brand new 30 year? Because your payment might be less, but that can be deceiving, because you’re paying longer.

      This is why I do

      Closing_costs / (Rate_difference X balance) = breakeven

      • breakeven = years in this equation.

      • Jim says:

        That’s very true, but on the flip side you can always refinance down to a 15 year if you choose to (say you’re at 17 years left).

      • Kosmo, that’s another issue, but it can be solved with a loan term equal to the remaining term of the original. Not many people do that, so your point is well taken.

        Ironically, what complicates the decision is that most people try to oversimplify by obsessing on rate and payment. But there are no small number of people who’d be a lot closer to payoff if they hadn’t refinanced every time there was downward blip in rates.

        If you bought your house 10 years ago with a 30 yr loan, but refinanced five times over that span, including this year, and each time into a new 30 yr loan, you’ll have added 10 years of interest payments on top of the purchase loan. That’s 40 years, assuming you don’t refi again! If you’d done nothing, you’d already been 1/3 of the way through the original loan term!

        • Agreed. You shouldn’t refi at every blip. Unless you have a $10 billion house, in which case, a blip can cause a huge drop in payment :)

          If you compare loans of equal term, we should arrive at the same breakeven, regardless of whose formula we use – because we’re just utilizing the same numbers in a different manner (essentially, utilizing the transitive property to show the same equation in different ways).

      • Richard says:

        I’ve done loans where we did that same switch but they paid it off in 12. Again, also got to take into account how the interest is figured and how one pays.

        • The key phrase was “and each time into a new 30 yr loan”. To expand Kevin’s example:

          New mortgage in 2009
          2011: trade 28 years remaining for new 30 yr
          2013: trade 28 years remaining for new 30 yr
          2015: trade 28 years remaining for new 30 yr
          2017: trade 28 years remaining for new 30 yr
          2019: trade 28 years remaining for new 30 yr

          10 years later, you still have the 30 year mortgage. This would, of course, be a horrible thing to do.

          When we refi’d, we kept making the exact same payment (which already had some extra added to it). This will slice a couple more years off our home indebtedness.

          • JoeTaxpayer says:

            Kosmo – I mostly agree. I have refinanced 3 times, 30-30-20-15, the only reason I went from 30 to another was we still had high expenses (a Nanny) and I knew that would end and rates were still dropping. All three were no point/ no closing.

            When we bought the house, I wanted to pay it off before retiring. Now, the goal is to have it paid before 10yr old starts college, and retire after she’s graduated. So 20 years after we bought the house it will have no mortgage.

            But to play devil’s advocate, a 10 yr arm, interest only the first 10 years, then refinanced into a 30 yr fixed is almost just what you describe above. If rates are dropping, and that 30 is near the bottom, that borrower is pretty happy, and the situation isn’t so horrible.

          • Richard says:

            I understand. What I was getting at was I’ve taken people from existing 30 yr notes and put them in another 30 year note at a higher rate, saved them money, and showed them how to pay it off in 17 years without doing anything different. 10 years if they really applied themselves.

            Again, it’s also understanding HOW the interest is figured as well as how one pays. I’ve yet to see a calculator that takes that into effect or anyone focus on those subjects.

  6. freeby50 says:

    For the engagement ring, I agree about communicating and deciding. Deciding what is important to her in a ring is pretty important. But it doesn’t hurt to have a guideline like 1-2 month salary as a limit.

    With student loans I don’t see a big difference between total loans equal to salary and shooting for 10-15% debt to income ratio. Either way is going to end up mostly equivalent unless the interest rates are significantly different.

  7. It seems pretty hard to talk about engagement rings with your significant other without letting on that you are planning to propose. A halfway intelligent girlfriend would figure out what you were getting at unless the conversation arose from a completely random source (like another friend initiating the conversation). And my girlfriend and I have been fielding demands to know when we’re gonna get official for months now so she knows that whenever a question like that pops up we both clam up or giggle and move on.

    • Jim says:

      I think you get to the point in a relationship where you know you’re eventually going to get married. When the time comes for the proposal, regardless of what you may think, the other party has a general idea that it’s happening. If they didn’t, they wouldn’t sticking around if it was important to them.

      That being said, you can go “ring shopping” or talk about it casually to at least get on the same page. Even if she knows it’s happening, it’ll still be a surprise and a welcomed one at that.

  8. My Journey says:

    Here are 2 that I think need refreshing:
    1) Your Home is your best investment (go ahead and link to your bad ass Devil’s Advocate Post from a couple days ago)

    2) Buy Term and invest the difference:

    http://www.myjourneytomillions.com/articles/give-whole-life-insurance-a-fair-comparison-get-illustrations-and-compare/

    • Richard says:

      Your home is NOT an investment, unless it generates income for you, it is a liability.

      In order to do BTID, both sides MUST be done. In the example given in the article, I would have done a 30 or 35 year term with the difference at 10%. There are even muni-bond funds doing 8% on average.

      • My Journey says:

        Richard,

        In the spirit of the post, I meant both those as items as common knowledge that needs to be updated.

        I also do not think your home is best investment.

        Most AAA companies (and there are only a few insurance companies with AAA) do not carry 30 or 35 term. You can’t just make up the difference of 10% you have to run the illustrations lol. Those numbers were actual illustrations I ran.

        The muni bond at 8% is SHOCKING I’d love to see a AAA rated 8% Muni bond because thats where I am going!

        I could

        • Richard says:

          There are 2 companies that are A- or better that DO carry 35 year terms and many more that also carry 30 year term.

          If all you want is highest possible rating, you leave plenty on the table for better investments.

          For those in the 35% tax bracket, the Van Kampen High Yield Muni (Tax Free Bond Fund) has generated 8.1% after tax equivalency is taken into account.

          It’s a BB bond fund that has an equivalent default rate to a AAA Corp Bond Fund. YTD: 18.66%.

          VK: Equity and Income fund has done over 10% since inception. YTD: 12%.

          The responsible investor will balance risk with reward and understands that if they want the higher rates, they NEED to take risk.

          By putting all your money into the safest possible investments, you should just buy a whole life policy. Your returns will be equivalent since all you get in a whole life is the guaranteed cash value and nothing else.

          • My Journey says:

            Maybe I should have made myself clearer, I am sorry that is my mistake. I just meant to point out that buy term and invest the difference (however that is defined) should not be a rule of thumb automatically.

        • Richard says:

          BTID is not a rule of thumb, it’s a concept that must be applied on both sides to work.

          For the vast majority of people, it works as advertised so long as the person sticks to it.

          • My Journey says:

            Richard,

            “For the vast majority of people”

            I took it from a “theoritical rule of thumb” down to the brass numbers. At 8% NET BTID (which I didn’t know was an acronym) will always win after a decade or so….at 5% NET return it is close into the 20th year OF CONSISTENTLY, NO CHEATING BTID, but at 2% NET RETURN (i.e. saving that extra money in a savings account) WHOLE LIFE WILL WIN probably into the 50th year.

            My whole point of the post was to just say sometimes you shouldn’t just listen to the annoying financial planning pundits on your major news network.

          • Jim says:

            “My whole point of the post was to just say sometimes you shouldn’t just listen to the annoying financial planning pundits on your major news network.”

            Can’t say I disagree with that. :)

          • Richard says:

            My Journey,

            The problem with whole life, when you pass on, all that cash you built up, you lose if you don’t get to it before you pass on. Then, unless you put it into a qualified account or the growth is below your tax basis, your heirs might have to pay income and estate taxes on it.

            Whole life is only a great deal for the agent due to the average of 80 to 200% commissions on it. Why else would you have a -100% growth on your money the first few years.

            And frankly, I don’t watch TV except for Nick & Disney with my kid and NCIS, SyFy, and Food Network. No news stations.

            However, the millionaires’ I do socialize with, NONE of them touch cash value policies of any kind. They are just bad all around.

          • My Journey says:

            I have never sold a policy, but work in an office where policies are sold.

            Not one agent gets paid 200% not one, not even the top agent in the office (who is the in the top 5 of the Fortune 100 Company I work for). Most get 45 to 50% of First Year Premiums, but fade down QUICKLY. The Payout % is very similar to term, but as you have mentioned term costs less so the net payout is less.

            I have been involved with the implementation of whole life (as my role in the office, but not as salesmen) for many many multimillionaires who wanted whole life for various reasons (not everything is about income replacement) here is a guest post:

            http://cashmoneylife.com/2009/05/15/reasons-to-buy-whole-life-insurance/

            We can go back and forth, and I am alright with that because you are obviously intelligent…but in the end If the product sucked that much and didn’t help at all it wouldn’t exist. LI Salesman, Financial Planners aren’t playing Jedi Mind tricks (a lot of them are quite the opposite as I am sure you’ll agree) some people are into it, some people aren’t.

        • Richard says:

          Sadly, I’ve seen some commissions that high. Not all were on whole life specifically, but all were on cash value products. Just because your office doesn’t get them that high, does not mean they are not there.

          If those multi-millionaire clients knew of other options that are available, they probably wouldn’t put money into a WL type policy. The ones I deal with, get those options. When they deal with other advisors that mention cash value policies, they kick them out and move on.

          On that post, 1 of those situations is better covered using lower cost key-man term insurance. The other 5 can be take care of using trusts and annuities. Both allow the protection they seek as well as greater growth potential with lower fees.

          Whole Life is a sham and was created to increase profits. When those profits started dropping, the insurance companies started creating other cash value policies (UL, VUL, VL) to fit different times of the market so they can keep profits higher. UL was actually created as the answer to BTID.

          • My Journey says:

            Pre-2007, how many times have you read that Annuities are the worst financial products? Now, despite those “crazy fees”, pundits (the SAME pundits that hated them a decade ago) are claiming they are amazing because of the guaranties.

            To each their own.

          • Richard says:

            I don’t listen to those people. Again, don’t watch news or read newspapers.

            Annuities are tools. When used properly, they are great. They got their bad rap from agents who used them improperly.

            I have a client that is about to retire, they have annuities from another company. If they were to move them over, they would lose between 10 and 20% of their retirement. They retire next year. Those annuities also have a cap on what they can earn. The underlying investments have been doing 10/15% growth the last few months. They only got 2% and lost the rest. Not from fees, but because of the guaranties.

            As for the fees, having little to no fees can be more detrimental than having moderate fees. Just as having too many fees will kill the return. There has to be a balance. WIthout that balance, it’s a bad product. With it, they are great products for specific tasks.

    • dilbert69 says:

      The argument under the link you provided seems to be a counterargument to “buy term and DON’T invest the difference,” which no one in their right mind would advocate.

      Life insurance (which should be called premature death insurance because that’s what it protects against) is not an investment. It is insurance; i.e., a risk-management product.

      If you are single and have no heirs, there’s no reason to purchase premature death insurance, as your death won’t affect anyone financially. You may want to purchase a small policy to cover your funeral expenses, but other than that, there’s really no point.

      If you’re married and childless and you spouse earns a solid income, there’s still no need to purchase premature death insurance, as your spouse can just go back to being single on his/her own income. If he/she can’t afford the house payment, he/she can sell/rent out the house and move someplace cheaper, or take in a lodger.

      If you have children, a spouse who earns little or no money, or other dependents, and you want them to be able to continue the same lifestyle in the event of your premature death, you should purchase a sum of life insurance which, conservatively invested, would yield your monthly income less your monthly consumption from now until the time you plan to retire. In a perfect world you would reduce the amount of coverage each year you don’t die, but that’s obviously not an option.

      That being said, I did purchase some term insurance through work because it’s dirt cheap, and my wife will be able to stay in the house by herself if I should die prematurely, provided she invests the lump-sum payment properly. She couldn’t get much insurance, so I’d probably have to move in a year or so if she were to die prematurely, but I don’t really mind, as I don’t need a 2,000-square-foot house to myself.

      In summary, term life insurance is often unnecessary, and whole life insurance is a huge ripoff for the financially disciplined. If you’re not good with money, it might be a good idea, but I wouldn’t know. :-)

      • My Journey says:

        “The argument under the link you provided seems to be a counterargument to “buy term and DON’T invest the difference,” which no one in their right mind would advocate.”

        Quite the opposite. I said most people don’t invest he difference, one because how would they know the difference. But beyond that, I showed the calculations of investing the difference? Didn’t I?

        Although maybe you disagree with the numbers I used as Richard did?

        • Andrew says:

          I wasn’t criticizing what you wrote, but what the author of the article you linked to wrote. Their argument for buying whole life rather than buying term and investing the difference was that most people don’t invest the difference. That’s highly illogical. As for knowing what the difference is, wouldn’t that be a simple matter of the monthly difference in premiums? I’ll confess to knowing as little about whole life as I know about astrology, palm reading, and religion. :-)

          • My Journey says:

            I am the writer LOL. What I was saying is that if someone was so set on term they probably wouldn’t have received the whole life premium amount, so there is no difference (i.e. Whole Life Premium minus Term)

      • Richard says:

        The problem with work insurance, it takes forever to pay out. Average out of my office is 6 months to never before it ever does. Can your wife keep things going while waiting for the money?

        It’s dirt cheap because of how little it is and how much your company is paying. You are better off getting a separate policy.

        It’ll pay out faster and YOU control the policy and not someone else.

        • Andrew says:

          It’s a moot point because I probably couldn’t qualify for an individual policy at an attractive enough rate. Remember, my wife doesn’t need the money. And yes, she could easily live on our savings for six months. As for it paying out “never,” what exactly do you mean? Are you saying the carrier denies legitimate claims? This sounds like a class action lawsuit waiting to happen.

          Also, it’s not dirt cheap because of how little it is. It’s two or three times (I forget which) my annual salary, which is not insubstantial.

          • Richard says:

            A group policy could fail to pay out for any number of reasons including failing to die while being on the clock. If you don’t have the actual policy in hand, you wont know when it will pay.

            It also may not pay if the company fails to submit a premium payment (has happened enough times to warrant a mention). The most common though, no one knows who to file the claim with, even the HR person, so they just keep filing and getting passed around. It either gets paid or lost in paperwork or flat out denied.

            Group policies are typically cheaper per thousand because the company pays a portion of it and you just pay any over that. In addition, when your company decides to change carriers (usually happens once every couple years) to save on costs, you may lose any additional coverage you have simply because they asked medical questions and you got them wrong.

            If you have a medical conditions, group policies are great (medical included). If you and your wife are healthy, ditch them and get a private policy. You’ll save money and get a better one.

  9. dilbert69 says:

    I think it’s funny that two of your non-financial examples have been debunked. There’s no danger in going swimming soon after eating, unless you’ve eaten so much that it’s made you drowsy, but that would be covered under “Don’t swim when drowsy,” which should be obvious. As for mixing hard liquor and beer, it doesn’t make a bit of difference. Ethanol is ethanol. The fewer impurities, the less sick a given quantity of ethanol will make you. That’s why I drink top-shelf brands when I drink, which I rarely do.

  10. dilbert69 says:

    The engagement ring rule of thumb makes no sense. What if you live in an area with high salaries and high living costs? Shouldn’t the price you’re willing to spend on just about anything be some function of your disposable income rather than your total income? Also, are we talking just an engagement ring, or an engagement ring and a wedding ring? I think I spent 60-70% of one month’s salary on my wife’s engagement ring, and she’s very happy with it almost eight years later.

  11. eric says:

    I’m running out of thumbs. :)

  12. Chelsea says:

    Hi Jim,

    Good post. We just discussed financial rules of thumb here in Quickenland yesterday. Funny, one that many Americans (including me!) break: don’t get into credit card debt.

    On the wedding ring thing, I’ve got tons of friends that have recently become engaged. Almost all of them had a brief discussion about rings with their significant others before taking the dip. Think it’s somewhat the norm for my generation at least.

    - Chelsea

  13. One other myth that needs to be debunked is the level of debt. I think the old rule of thumb was about 28-33% was a reasonable level of debt. I personally think it should be somewhere around 20-25%.

  14. Carla says:

    These days I rarely see a woman wearing a *bling* engagement ring no matter what their financial situation is. I guess people are no longer following the old DeBeers marketing tactic for their blood diamonds.

  15. This past year I’ve been forced to reevaluate many of the rules of thumb I’d previously been able to rely upon. I suspect many people have started to increase the size of their emergency funds; I was always comfortable using 3-months of expenses as my rule, but lately I’ve been trying to increase to 6-months. Any thoughts on using a Roth IRA as an emergency fund, as contributions can be withdrawn tax/penalty-free?

    • Richard says:

      Don’t. A Roth is a retirement account not an emergency fund. You will get penalties if you withdraw before your retirement age.

      I would actually suggest you get between 6 and 12 months emergency fund into either a savings account or a money market mutual fund account.

      • Jim says:

        I agree with Richard, your Roth IRA should be for retirement. Money that goes in shouldn’t come out until you retire… or you’ll regret it when you do.

        • Andrew says:

          If you have a prolonged period with no income and you exhaust your non-retirement savings, you may be left with a choice between exhausting your retirement savings (and paying any back taxes and penalties) or being homeless and starving to death. Kind of makes retirement seem a lot less relevant, huh?

          • Richard says:

            Andrew, you missed his question. He was asking about putting his money into a retirement account for emergency fund purposes instead of a legitimate emergency fund.

            None of us have ever suggested one starve before tapping ones retirement account for money.

  16. dilbert69 says:

    I had a feeling, after I posted, I might have missed the point. I agree that a retirement fund is not a substitute for an emergency fund. I think one should fund one’s retirement fund just enough to get the maximum employer match, then establish an emergency fund of six months’ expenses, then max out the retirement fund to get the maximum tax benefit.

    • Richard says:

      I usually recommend people max out their companies match in their 401k while focusing on other retirement accounts and their emergency fund. Do a little into each to make sure they all grow.

      Missing a couple months in a retirement account can be a several thousand/hundred thousand dollar mistake.

  17. Damon Day says:

    How about, do not take on consumer debt just to purchase something that you do not want to wait a few months to save up for. Don’t spend more on your credit card than you can afford to pay in full when the bill arrives. There is no good reason to buy a pair of shoes or a purse or any consumer item that is not a necessity if you cannot pay the bill in full.

  18. theaccusersgift says:

    During the Great Depression, parents would advice their children never to spend more than 25% of disposable income (net paycheck) on housing (or rent) expenses.

    Buying used cars 3 years old has changed to buy used cards 5-7 years old because of the increasing quality of cars.

    Only replace a car when either a) the body falls apart b) you have to replace an engine c) you have to replace the (an entire) transmission (as opposed to just the clutch) or d) you total the car.

    One needs at least a tri-level emergency fund for 3 different needs: http://frugaldad.com/2009/07/20/the-tri-level-emergency-fund/

    And yes, because you can withdraw contributions from a Roth-IRA at any time without penalty, a Roth-IRA as a “Level III Mega Emergency Fund” makes sense as long as the Roth is not your only retirement fund (e.g. you are also funding your 401(k) to the max at the same time).

    Don’t depend on Social Security. It will only be available as a “safety net”.

    Don’t depend on a pension. The PBIC is dead broke. If you are lucky you may get 10% of the amount you were promised.

  19. Great post– one of the best I have seen in weeks. The diamond engagement ring scam is one I have posted on as well. Many rules of thumb are made up by scammsters and are self serving . . .


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