Thumbs Up to the Rules of Thumb
November 08, 2011When ordering take-out last night for my family, I used a rule of thumb that when you order Chinese food, you should ask for one entree less than the number of people in the group to avoid unwanted leftovers. Between the four of us, we split Chicken and Broccoli, Hunan Beef, and Sesame Chicken. Even with only 3 entrees, we each got a second helping and our dessert of fortune cookies, and there were NO leftovers.
So how can employees consider rules of thumb during open enrollment season? Here are some common rules of thumb that make sense when deciding on employer sponsored benefits:
Ø If you have loved ones who rely on your income, you should have 10X your pay as life insurance coverage.
Ø Save at least 10% of your pay towards retirement.
Ø What you spent last year in out of pocket medical costs is the amount you should put in your Flexible Spending Account for next year.
Ø If you are young or in a low tax bracket now, contribute to the Roth 401(k).
Ø Don’t hold more than 15% of your net worth in your own company stock.
I typically use these as benchmarks when I facilitate workplace financial education workshops. This gives my audience a quick and simple guideline to follow with their own finances. A recent study by MIT on Keeping it Simple: Financial Literacy and Rules of Thumb, now confirms that people who were offered rule-of-thumb based training showed significant improvements in the way they managed their finances as a result of the training, relative to the control group which was not. Their challenge was to determine whether and how financial literacy can be taught and, closely related, whether there is causal link between improving financial literacy and financial outcomes. The authors focus on the tradeoff between a standard approach , which teaches the fundamentals of financial accounting, and training based on simple rules of thumb. The latter provides a simplified view of financial decision making, teaching easily implemented decision rules without explaining the underlying accounting motivation.
A blogger on msn.com moneycentral identifies 16 of her favorite money rules of thumb that employees can follow with their personal finances, mostly revolving on debt issues such as how much of a car they can afford with her 20/4/10 rule (put 20% down, borrow for no more than 4 years, and the monthly payment should be less than 10% of your monthly pay), and that student loans should be no more than what is expected as the first year’s earnings after graduating.
Although rules of thumb are really just meant as a starting point , they provide a favorable shortcut to making a decision, which certainly beats not making any decision at all.