What is a rule of thumb?

A rule of thumb is a general, simplified principle to help guide your investments. For example, always save 5% of your earnings to use in case of an emergency. The phrase is often said to come from an English legal ruling that allowed a man to beat his wife with a stick so long as it was no thicker than his thumb. This is thought to be untrue, and instead the phrase derives from one of the numerous ways that thumbs have been used to estimate things over human history, such as temperature of beer, judging alignment or distance of an object.

Where have you heard about rules of thumb?

There are many rules of thumb when it comes to investing. For example, there's the 4% rule. This is where in retirement, you withdraw 4% of your nest egg's value each year, plus the value of inflation in every subsequent year. This rule aims to stop retirees running out of funds.

What you need to know about rules of thumb.

Some other common financial rules of thumb include:

The 50/30/20 Rule for Budgeting
The rule suggests 50% of income should go towards necessities. 20% should go towards financial goals, like saving or paying off debt. Finally, 30% should be allocated to wants, such as dining or entertainment.

The Age Rule for Stocks
Bonds are generally considered a conservative investment, and stocks more risky. Experts say the older you get, the less you should invest in stocks. The rule of thumb is to subtract your age from 120 to give the percentage of your portfolio that should be invested in stocks.

Although rules of thumb can be useful guides to financial dos and don'ts, they should never be taken out of context. By definition rules of thumb try to take complex concepts and simplified them. And although this can be useful to be aware of, it's always important to take into account your individual circumstance and attitude to risk. There are always exceptions to every rule and the financial markets are often volatile.

Find out more about rules of thumb.

The most common rules of thumb are usually around savings and retirement.