“Stupid” Rules and Principles
LFG Marketing | April 2019
An investment professional who publishes a daily newsletter of market commentary was asked by one of his readers “Do I need a budget?” The investment professional said, “Probably not.” Rather, he said, the best way to become a successful investor was to first engage in “radical saving,” to save as much as humanly possible, even to the point of mild discomfort. This means forgoing even small indulgences to build a financial safety net as fast as possible. “Only after you have established good saving habits should you start investing.”
Then the publisher allowed that some people, because they have no fiscal discipline, must follow a budget:
“I am sorry that these people exist. As many others have observed before me, rules are for the stupid.”
Whoa. Didn’t see that coming, did ya?
Rules are for the stupid? And there are “others” who have arrived at this conclusion before he did? Time for fact-checking. An Internet search of “rules are for the stupid” doesn’t generate a match. But it does bring up this quote:
“Rules are for the guidance of the wise, and the obedience of fools.”
This statement is attributed to Harry Day, a World War I ace in the British Royal Flying Corps. And although Day applied it to aerial combat decisions, the newsletter writer’s mangled version reflects the same behavioral insight: some people can’t function unless they have rules to follow.
The Difference Between Rules and Principles – and the Tension
In psychology, and particularly in behavioral economics, the distinction between rules and principles, and how people respond to them, is a hot topic. Sometimes it appears rules are more effective, and sometimes it’s principles. The distinction between the two terms? Productivity consultant Francisco Saez offers the following definitions:
- Rules are standards “which must be complied with because it has been agreed within a community.”
- Principles are “fundamental ideas that govern someone’s thought or behavior.”
Rules are specific instructions that clearly delineate “good” or “bad.” Principles are broader statements, usually accompanied by supporting logic, but often without a specific course of action. Rules and principles can also be seen as a distinction between external and internal motivation. Saez elaborates: “Although both things determine the way you act and make decisions, rules are imposed from the outside and must be obeyed to avoid incurring some kind of penalty, whereas principles are internal, and motivate you to do what you think is right or correct.”
A budget is an external imposition, while radical saving usually arises from an internal drive to achieve.
Rules: Pros & Cons
The prevalence of numbers in personal finance makes it easy to establish rules, because mathematics is a rule-based discipline (2 + 2 = 4. Always. That’s a rule.) It is possible to manage your personal finances exclusively by using rules – no principles required.
In 2010, Charles Farrell, an attorney and investment adviser, published Your Money Ratios, a book of formulas in which “readers need only to plug their income and age into Farrell’s ratios to get an instant picture of their overall financial health, as well as a road map for the important choices they must make in the future.” And it’s easy. Says Farrell: “If you know how old you are and how much you make, you can master retirement planning.”
Farrell’s book is representative of the strengths and weaknesses of a rule-based approach.
Rules make clear distinctions; clarity helps people act. Rules, especially ones embraced by a large segment of the populace, are psychologically reassuring; there is comfort in knowing our decisions align with the majority. Adherence to rules can insulate us from public humiliation should our plans under-perform; after all, we were “just following the rules.”
Rules have downsides, too. A failure to keep to a standard can be frustrating (“There’s no way I can save 20 percent each year!”) and over time, lead to despair (“We’ll never have enough to retire.”) Following rules might keep us from pursuing better options. If your rule for saving is 15 percent of annual income, you might not consider saving 25 or 35 percent in a prosperous year, even though that extra could be valuable if you have a few years of under-saving.
And, as one lawyer says, “Rules are things you get around by clever thinking.” We have a tendency to shortcut rules, frequently to our detriment. Didn’t save enough last year? Maybe you’re clever enough to achieve a higher rate of return instead. (Usually accompanied by greater investment risk, i.e., a greater chance of not succeeding.)
Principles: Pros & Cons
Rules are abundant in personal finance, but there are plenty of principles, too. Even though money can be quantified with numbers, there are diverse perspectives on financial success.
Some principles have broad consensus, like living within one’s means and saving; no one argues against that. But others
generate more debate: Is tax-deferral really the best format for retirement accumulations? Should a personal residence be considered an investment or an expense?
Unlike rules, principles leave room for flexible interpretations and creative solutions. For example, buying new equipment could be a “retirement investment” for a small business owner because of an anticipated increase in revenue. A permanent life insurance policy could be the liquidity for an estate plan, or supplemental retirement income* – and the decision might not be made until much later.
Principled decisions require a higher level of personal responsibility; you have to “own” the decision and formulate a plan of action. Principle-based decisions may be uncon-ventional, which can be uncomfortable; if the results are less-than-favorable, you don’t have the alibi of “Well, I was just following the rules.”
In theory, principle-driven decisions may be more desirable, but that doesn't make rules bad, or rule followers stupid. There are some interesting studies on how default enrollment (a “rule”) affects employee participation in retirement plans. Automatic enrollment is found to increase participation, but the most aggressive savers are those who voluntarily exceed the default percentages. Those who entered under automatic enrollment tended to not initiate increases, but simply accept the default percentage.
A general observation is that rule-keepers may under-perform those with principle-driven motivation but out-perform those with no guiding principles; a rule-centric financial plan is better than having no plan.
Rules or Principles? Yes
In an ideal world, simple rules derived from solid principles make for easy and wise decisions. Unfortunately, rules and principles often get disconnected: we may follow the rules while being ignorant of the principles behind them. Or we might agree with a principle, but not know how to translate it to a specific action. The best outcomes occur when we know our principles, and know that our actions are aligned with them.
But that level of engagement is a lot of work; you have to be deep into your financial plans to achieve this integration of rules and principles. Or you could collaborate with your financial professionals. They should be able to articulate the principles and recommend rules that fit. So…
* Do you know your financial principles?
* How well do you follow your own rules?
* Do you know the guiding principles of your
* Do your relationships with these professionals
make it easier to act on your principles?
If you know your principles, rules aren’t stupid.
Rules make principles easier to live by. v
* Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.
Lifetime Financial Growth, LLC is an Agency of The Guardian Life Insurance Company of America® (Guardian), New York, NY. Securities products and advisory services offered through Park Avenue Securities LLC (PAS), member FINRA, SIPC. OSJ: 244 Blvd of the Allies, Pittsburgh, PA 15222 (412) 391-6700. PAS is an indirect, wholly-owned subsidiary of Guardian. This firm is not an affiliate or subsidiary of PAS. 2019-77341 EXP 3/2021
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