What Are Rules Of Thumb? How To Make Decisions Fast

A rule of thumb is an approximate method for doing something. An approach to decision-making, problem-solving, and evaluation based not on theory but on practical experience. The usage of the phrase dates back to the 17th century when various quantities were measured by comparison to the width and/or length of a thumb in trade. The width was used as the equivalent of an inch in the cloth trade. Nowadays, it refers to any heuristic guideline that provides simplified advice regarding a subject or course of action.

The principle is using practical experience to quickly accomplish a certain task or make a sound decision. Thorough scientific and theoretical research is not needed at every step. Investors are familiar with financial rule-of-thumb decision-making. These are standard procedures for saving, investing, making purchases, and planning for retirement. Although rules of thumb are appropriate for wide audiences, they do not apply universally to every individual and unique circumstances.

A few instances of financial rules of thumb. Several are well-known and widely applied. A home purchase should cost less than an amount equal to 2.5 years of your annual income. Save at least 10-15 percent of your take-home for retirement. Have at least 5 times your salary in life insurance death benefit. Pay off highest-interest loans first. The stock market promises 10 percent yearly returns. Have an emergency fund equal to 6 months of household expenses. A balanced portfolio is 60 percent stock, 40 percent bonds.

Take rules of thumb with a grain of salt. They are oversimplified in many situations. Do not have them lead you to underestimate or overestimate your needs. They do not account for specific circumstances and factors that change over time. Rules of thumb are, by definition, simple and practical guidelines to solve problems based on horse sense. These are employed automatically when you face uncertainty or when the cost of obtaining information is too high.