5 Financial Rules of Thumb: When They Work and When They Don’t

May 23, 2023

Financial rules of thumb help us make decisions, but if applied too broadly, they may underestimate or overestimate an individual’s needs.

Which rules of thumb make sense and which don’t?

Here are five examples, all assessed for accuracy:

1. The 100 Rule: Take 100 and subtract your age. That’s the percentage you should invest in the stock market versus the bond market. In other words, your current age represents an appropriate bond allocation for your stage of life. If you are 60, your portfolio allocation should be 40% stocks and 60% bonds. If you are 40, it’s 60% stocks and 40% bonds.

Verdict: This rule encourages more conservative investments as you get older. However, each person should assess their situation to see if this is right for them. If you become too conservative, holding more bonds than you need with a (seemingly safe) 3-4% return, you may not keep up with inflation. The last thing you want is to run out of money before you’re ready.

2. The Savings Rule: Save at least 10-15% of your take-home income for retirement.

Verdict: Generally, this is a great rule of thumb that applies to almost every situation. However, the success of this rule depends on whether or not you’ve allocated appropriately. Let’s see some numbers:

– Setting aside 10-15% of your income and sticking it under your mattress won’t do much with the effects of inflation. If inflation is 6%, the purchasing power of your money will be worth half in about 12 years (72/6=12). At 4% inflation, you can expect an investment to lose half its value in 18 years.

– Let’s say you invested your savings instead. If you earn a 3% net return, it will take 24 years to double your money. In retirement, you may need to withdraw 4-6% each year to cover your expenses. Accounting for fees and inflation, your distribution could bump closer to 8% each year. Was the 3% return enough? You won’t know unless you’ve built a plan and accounted for your circumstances.

3. The Life Insurance Rule: Have at least five times your gross salary in life insurance death benefits.  

Verdict: Life insurance is essential, especially if you are the sole income earner with loved ones to support. Is 5x your salary too little or too much if something were to happen to you? It depends.

Buying life insurance based on a multiple of income does not account for the specific needs of the surviving family, which may include a mortgage, college funding, and an extended survivor income for a non-working spouse.

But if you are the sole income earner with no family depending on you, you likely won’t need 5x your income put away. Your decision should account for your family, stage of life, and financial standing. Context is key.

4. Credit Card Debt Rule: Pay off your credit card with the highest interest rate first.  

Verdict: If you have credit card debt, this rule of thumb makes sense mathematically. If a borrower pays 12% interest on a credit card (or any other form of loan charging compound interest), the amount they owe will double in six years. Pay off that high-interest debt first. Of course, if you can avoid credit card debt altogether, that’s even better. 

5. Stock Market Long-Term Average: As a long-term average, you can count on the stock market for a 10-12% rate of return. 

Verdict: In the investment world, we often encourage clients to hold on for the long term and avoid reacting to the roller coaster ride of the market, as 20-year rolling returns do tend to yield 10-12%.

Even still, plan for contingencies. The economy can affect returns. In the 1960s and 1970s, for example, inflation spiked, and the stock market saw almost no returns for about a decade. A lack of a 10-12% average return means there is an opportunity, so don’t react too rashly. Instead, talk with a team and adjust your plan accordingly.

Financial rules of thumb aren’t always as simple as they first appear. The best way to make decisions is to assess your lifestyle, goals, and limits and work with an expert to decide the right course of action.

If you have any questions about what makes the most sense for your lifestyle and retirement, reach out to our team at [email protected].


Investment advice offered through CX Institutional, a registered investment advisor.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in the presentation may not develop as predicted.

All data is sourced from Bloomberg, through the release of monthly figures from the U.S. Bureau of Labor Statistics or from the Federal Reserve and any of its affiliated regional location.



By Doug Lockwood, MBA, CFP®

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