DEFINITION of 'Rule Of Thumb'
A guideline that provides simplified advice regarding a particular subject. A rule of thumb is a general principle that provides practical instructions for accomplishing or approaching a certain task. Typically, rules of thumb develop as a result of practice and experience rather than scientific research or theory.
Investors may be familiar with a variety of "financial rules of thumb" that are intended to help individuals learn, remember and apply financial guidelines, including those that address methods and procedures for saving, investing and retirement. Although a rule of thumb may be appropriate for a wide audience, it may not apply universally to every individual and unique set of circumstances.
INVESTOPEDIA EXPLAINS 'Rule Of Thumb'
There are a number of rules of thumb that provide guidance for investors. Well-known financial rules of thumb include:
- A home purchase should cost less than two and a half years' worth of your income.
- Always save at least 10% of your take-home income for retirement.
- Have at least five times' worth your gross salary in life insurance.
- Pay off your highest-interest credit cards first.
- The stock market has a long-term average return of 10%.
- You should have an emergency fund equal to at least three to six months' worth of household expenses.
- Your age represents the percentage of bonds you should have in your portfolio.
- Your age subtracted from 100 represents the percentage of stocks you should have in your portfolio.
There are also rules of thumb for determining how much net worth you will need to retire comfortably at a normal retirement age. Here is the calculation that Investopedia uses to determine your net worth:
If you are employed and earning income:
((your age) x (annual household income)) / 10
If you are not earning income or you are a student:
((your age – 27) x (annual household income)) / 10
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