PF Hour Episode 26: Jim and JD Talk About Personal Finance Rules of Thumb

by brian on November 9th, 2009

This week’s show had both Jim and JD looking at the financial rules of thumb that guide our personal finance decision making. These rules of thumb were created somewhere and usually have some validity for them to stick throughout the years. They examine these “rules” a bit deeper this episode.

The guys started off with an anecdote about a recent furniture shopping adventure that JD undertook at IKEA. This made Jim ask is there a rule of thumb out there that IKEA is just naturally the frugal choice for furniture? After the guys discussed it for a few moments, they decided that IKEA is great for disposable furniture. Furthermore, Jim has his own self-imposed guidelines when shopping at IKEA: the furniture can’t have by movable parts and you can’t plan on moving it from its original location almost ever.

There is some conflict about using rules of thumb for making decisions. Four pillars wrote recently that rules of thumb are bad because they are a poor substitute for proper analysis. Jim added he thinks that rules of thumb are for people that need to take action today and may not be well informed. It simplifies the decision to make someone more comfortable. With that caveat, let’s get going.

Saving and Investing

There are a lot of rules of thumb in terms of saving and investing.

Pay yourself first. Most people say you should save 10% of everything you earn. You should try and save more if you can, but to start building savings, it’s essential to pay yourself first.

Your asset allocation should be 120 minus your age (that is the percentage of your assets that should be in stocks).   This rule of thumb was discussed earlier with the guys when Jeremy from GenXFinance was on the show.  Jim states that this is a rough guideline for people that are just getting started. He doesn’t recommend shifting your asset allocation by 1% on your birthday each year. JF discussed that he actually takes a more conservative approach and goes with the less used rule of thumb 100 minus his age. Additionally, JD joked that his wife Kris unexplainably tends to be very conservative with her own investments but often urges JD to be more aggressive with his money.

You shouldn’t put more than 10% of retirement assets into employer stocks. This is explained because you are not diversified if your primary income and retirement income are both coming from the same source. Jim actually disagrees with this rule as he feels you should have 0% of your employers stock with only rare exceptions.

Assume an 8% long term return. There are lots of complications and caveats but that’s what the majority of people use as a guide when planning their long term investments.  Both Jim and JD use the 8% figure as a rule of thumb.  It’s essential to look at what your goal is and ask yourself will “X”% get you to that goal?  It’s also beneficial to give yourself high and low projections just in case the market under or over perform.  Lastly, readjustment of your portfolio may be necessary if you have just had an up or down year.  For a great example of this, check out Carl from Behavior Gap’s Post on Get Rich Slowly: Average is not Normal.

Callers and Chatters

Jason from the chat room added a common rule of thumb: Max out your employer’s 401(K) match benefits.  Jim and JD couldn’t agree more as this is free money.  In addition, Jim said that one of the rare occasions to invest in your company (as discussed earlier) is if you are offered some form of matching.

Baker (Man vs. Debt) called in to discuss the rule of thumbs for mortgage down payments.  There used to be a rule of thumb that 20% of the cost of the mortgage was an appropriate down payment.  Over recent years, that number shifted to 4% and then more recently 0% (which has helped lead us to our current economic crisis).  The banks tend to lend on those rules of thumb (and you can see where that got us).  Then the banks also have another rule of thumb that your mortgage payment should be no more than 1/3rd of your income.  Baker suggested that we consider rewriting these rules of thumb so that they work in our favor instead of banks or other institutions.

Dylan from the chat room gave another rule of thumb stating: It should take less than 3 years for you to break even on a refinance. This gets back to the core philosophy that Jim and JD both preach about staying in the same home for longer than 5 years.  Additionally, Tim Ellis wrote about Renting vs. Buying on GRS back in 2007 and his article still rings true today.

Nikunj called in to relay his current story about his 94 Acura with 210,000 miles.  He was curious as to if it’s in his best interest to purchase a new vehicle or get his fixed even though it appears on its last legs.  While not being car experts, it made sense for the guys to recommend it may be time for a new car.  15 years is a good run for any vehicle.


It’s almost always cheaper to fix your car instead of buying a new car. JD mentioned that Kris loves to listen to Car Talk and the hosts almost always recommend fixing your car to the point you feel comfortable driving it instead of trashing it.  However, if it will cost much more than the vehicle’s worth to repair, just to keep it running, your best bet may be to go and buy a different car.
Jeremy from GenXFinance suggested a rule when purchasing a car that discussed how you should finance your vehicle.  The rule was 20:4:10.  You should put 20% down, finance it for 4 years and drive it for 10.

Jim stated the rule of thumb that it’s best to buy a car used, or to buy it new and drive it for ten years.  Jim goes a bit further and states his own opinion that it’s important in personal finance to drive your cars into the ground.

Frugal Trader from MillionDollarJourney has a rule of thumb that states your mortgage should be no more than double your current household income.  For most people that would make home ownership a heck of a challenge.  Baker even went as far as to disagree with this as it sets limits from the wrong direction (what you can afford instead of you designating a certain amount for housing and then spending accordingly).

Jim mentioned Suze Orman as a means for coming up with an action-oriented rule of thumb prior to owning a home.  She suggests “pretending to play house” before you buy a home.  This means you should open up an account and start dumping a mortgage payment into it (the difference between your current rent), the cost of the extra utilities, insurance, taxes, etc.  If you do this for a number of months, you will likely be better prepared for home ownership.

You should refinance your home when the interest rates are 2% lower than your current rate. Jim wisely noted that this rule of thumb made more sense before there were computers and high performance calculators to help you calculate if your mortgage would actually be less expensive over the duration than if you were to keep it the same.

Miscellaneous and Concluding Thoughts

The guys ended the show about one other rule of thumb and Jim’s opinion on replacement purchases.

The rule of thumb was about windfalls and that you should use 1% of a large windfall to treat yourself.  However, the guys feel that it may be best to keep your spending small, build discipline and help yourself prioritize prior to spending that money.  It’s often best to let the money settle, pay the taxes on it, and then feel free to use that small percent to treat yourself.

Jim concluded the episode with his thoughts on buying replacement goods.  He once heard that you should buy a new appliance if yours needs to be repaired and is over 8 years old (or if the repair cost is half the price of purchasing the item new).  He uses this for even less expensive items as he amortizes them over how many years he expects them to last.  If the cost of the repair of an item won’t increase the life of the product to the point where the benefit outweighs the cost, he goes out and makes a new purchase.

Enjoy these rules of thumb and see you next week.

  1. Sleepless permalink

    My wife and I bought our home in Santa Cruz Calif., as a place for us to start a family… We bought the house in early 2007 for $599,000 and put $70,000 down (our entire life savings up to that point) and took out a loan from my mom for 40k at over 30 years. Now that the market has crashed in our area, our house is worth less. We are not sure what we could get from a sale of the home, but it would probably be about 70k less.

    Although our monthly mortgage payments are high, we can still afford to make them, but now with my wife not working and 2 kids we have no income left over after bills, we have cut all our fun spending and everything else for that matter to a minimum? If we walk away from the home we will not be able to refund any of my mom’s 40k and of course we would have to loose all we ever had previously saved. If we stay in our home, we’ll be stuck for many years, and in that time we will have no discretionary income. My wife will return to part time work in the future, but we can not count on (at least for now) much in the form of a second income. We were denied a loan re-modification, And could not refinance. The bank tacked on an extra 500 dollar a month tax charge this year as well when they contacted us after 2 years and explained that we owed back taxes because they had miscalculated our payment when we took out the loan. What would you recommend we do, I understand we never should have gotten ourselves in this position in the first place, but it is too late now. I could really use another opinion.. P.S I love your show!!!

    Thank you so much

  2. admin permalink

    I’m afraid I don’t know, you have a very complicated situation and one that I’ve never personally dealt with, so I’m not sure what the best course of action is. Are there others in your area in the same predicament that you could talk to? Perhaps your bank has advisors or counselors you could talk to?

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