We all have heard them. Anything from, “if you plan on living there for 3 years it’s better to buy than rent”, “you should contribute up to the max in a 401k”, or “index funds are the best way to go.”

I hate rules of thumb. Why? They provide a hint of truth with a quick and simple pseudo solution to a complex problem. The hint of truth is key, as it enables people who benefit from your decision to provide what seems to be legitimate expert advice. Of course, this advice is really not advice at all, but a means to ally your fears or cause you to doubt your own reasoning. You’re asking yourself, “How can a mortgage payment 3 times my rent be financially beneficial in 3 years?” At the same time someone who has been in the business for 15 years is telling you it will fine, so you start doubting yourself. Don’t doubt your own reasoning in these situations.

Here are some examples of rules of thumb, and why they are useless and dangerous to your finances:

• If you plan on living in the area for at least 5 years (it used to be 3) you will do fine financially by buying a house. This is one of the most ridiculous financial rules of thumb. Why? First, a house is probably the largest amount of money you will spend in your life by at least a factor of 5, but probably more. A 5 second sound bite shouldn’t determine if you’re willing to spend $300k on a house. Secondly, the amount of variables that go into determining if it’s better to rent or buy is huge (house cost, property taxes, interest rate, closing costs, points, utilities, monthly HOA fees, house appreciation, cost to rent, yearly rent increases, investment returns, etc.). Any one of these variables can drastically change the equation. Don’t rely on your real estate agent, rely on yourself. Here is good rent vs. buy calculator form the NYT. http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html#
• Contribute up to the max in your 401k. Not as bad as the rent vs. buy rule. However, you don’t want your retirement to rest on a 5 second sound bite. Examine what you get from your 401k. Does your company match contributions? Most will up to a certain percent of your salary, and if they do it’s almost always a good idea to contribute up the maximum amount matched. A 100% return is hard to beat. After you contribute enough to get the match take a long hard look at the investment vehicles offered in your 401k. Do they have expense ratios of at least less than .5% for domestic funds and below 1-1.5% for foreign funds? Are the historical average returns for the funds in your 401k comparable to the benchmarks associated with each type of fund? Is it easy and free to switch to different funds in the 401k? Don’t rely on anyone else to answer these questions go find the answers for yourself. Your retirement depends on it.
• Index funds are the best way to go. Not necessarily. If you don’t want to commit any time at all to your investment decisions, then by all means use them. However, if you are willing to put in the work, you can pick quality managed funds and pick individual stocks. You can get a higher return than an index fund, but it requires work. I don’t have any index funds in my portfolio.
• Save 10% of your salary for retirement. Maybe you want to live it up in retirement, or maybe you had kids and didn’t start saving until you were 40. Either way, you will probably need to save more. Here is decent calculator: http://finance.yahoo.com/calculator/retirement/ret-02
• Bad debt (credit card, car loan, student loans, etc.) shouldn’t be more than 20% of your income. I stumbled on this while researching this article and was amazed someone thought this was ok. Under no circumstances is credit card debt ok. Using a credit card is fine, but pay it off each month. Do not carry a balance. A car loan should be extremely minimal if you have to have one. Ideally if you can’t pay cash for a car you shouldn’t get it. However, this is difficult when you are starting out, so a small loan on a USED car is acceptable. If you need a loan for a luxury vehicle (BMW, Mercedes, huge ass SUV, etc.) you can’t afford it. Some student loans are ok, but make sure you think before you go in debt too far. Going in debt for $100k to be a lawyer, doctor or to work on Wall Street, is probably ok. Going in debt $40k to be a social worker is just plain foolish.
• Give away at least 10% of your net pay every month. This should not even be a rule. You should only give if you are covering all your basic financial goals with ease. Being virtuous and in debt isn’t a good way to live.

Nothing is too complex to figure out for someone who truly thinks for themselves. Your own thoughts are more valuable for any financial situation than some random arcane rule of thumb.