ET OnlineThe most crucial aspect of your financial planning is the awareness about the financial goal targets and how to allocate your savings to achieve them. There are many complex ways of determining these with great degree of accuracy, which many professional financial planners do. However, there are some very simple thumb rules that can help you get the same results which are close to professional calculations.
If you follow these rules you can easily know how your investments grow, the retirement corpus you will need and the growth rate your investment will require to achieve the goal. Moreover, you can also get an estimate of the insurance amount and the emergency fund required. Here, we take you through the 7 personal finance rules that can work on your financial well-being.
The rule tells you in how many years your investment will take to double its value. To get the number of years, you need to divide 72 by your annualised investment return, or interest rate.
If you are getting a 8% average return on your investment, your amount will double in 9 years= 72/8.
If the investment return is 10%, it will take 7.2 years to double the amount.
This rule will also help you make an estimate of the impact of inflation on your future life goals. For example, if higher education cost is Rs 25 lakh today how much money you will need after 15 years if annual inflation is 5%?
When we apply Rule of 72 and divide it by annual inflation rate of 5%, then the result that we get is 14.4. So, it will take 14.4 years for cost to double. So after 15 years, the higher education cost will be a little above Rs 50 lakh.
In case of 6% inflation, the cost will double in 12 years, while in case of 4% inflation, it will double in 18 years.
The rule takes into account the corpus you require at retirement and the withdrawal of it. You first need to calculate the retirement corpus. For instance, if your expected annual expense in the first year of retirement is Rs 10 lakh, you would need a retirement corpus of Rs 2.5 crore, which is 25 times of the first year’s annual expense.
And then, as per the 4% withdrawal rule, if you withdraw 4% annually from your corpus in the first year, while taking care of inflation each year, you can sustain the retirement corpus for a lifetime, no matter how long it is.
If you withdraw 4% annually from this corpus and the corpus is growing at a higher rate than the withdrawal, the corpus can continue for your life and keep growing.
50%- needs (groceries, rent, emi, etc)
30%- wants (entertainment, vacations, etc)
20%- savings (investment in equity, FD, mutual funds, etc)
As per this rule, you need to differentiate between need and wants and allocate funds accordingly. This rule puts emphasis on saving 20% of your income and investing it for future goals. However, you can go beyond this 20% saving target with some control on wants related expenses.
As per the rule, if you want to know the equity proportion required for your portfolio, then subtract your age from 100.
If your age is 35 years, you can invest 65% in equity.
100-35= 65% equity
The rest 35% can be invested in safer assets.
As your age increases, you need to decrease the equity proportion and increase the safer asset proportion.
This rule helps you in knowing your borrowing limitations. The rule says that the EMIs of all your loans should not be more than 40% of your monthly income. It will help you maintain your other expenses.
If your monthly income is Rs 60,000, your EMIs should not be more than Rs 24,000, which is 40% of Rs 60,000.
Similarly, if your income is Rs 1 lakh, EMIs should not be more than Rs 40,000.
This rule prevents you from falling into debt trap by knowing your limit up to which you can service your debt without putting your finances under stress.
Many people know the importance of life insurance, but they don’t know the minimum insurance cover they require.
The rule says that if you want to know the minimum insurance cover you need to have in your life, then multiply your annual income by 10.
If your annual income is Rs 10 lakh, your minimum insurance amount should be= Rs 10 lakhX10= Rs 1 crore
However, it is better to go beyond minimum, and it is advised by experts that ideally you should have a life cover of 15 times of your annual income.
3X emergency fund rule
We can face many financial emergencies in our life. These can be job loss, medical emergency, unavoidable home repair, etc. For those emergency situations, we need to have an emergency fund which should be readily accessible without any delay. In absence of the emergency fund, you may have to go for premature liquidation of your long-term investments.
The 3X emergency rule says that one needs to have an emergency fund that is at least 3 times their monthly income.
If you earn Rs 60,000 a month, the minimum emergency fund you need is Rs 1.8 lakh.
However, it is better to go beyond minimum and ideally one should have an emergency fund equal to six times of your monthly expenses.
If you follow these rules you can easily know how your investments grow, the retirement corpus you will need and the growth rate your investment will require to achieve the goal. Moreover, you can also get an estimate of the insurance amount and the emergency fund required. Here, we take you through the 7 personal finance rules that can work on your financial well-being.
Rule of 72
The rule tells you in how many years your investment will take to double its value. To get the number of years, you need to divide 72 by your annualised investment return, or interest rate.
If you are getting a 8% average return on your investment, your amount will double in 9 years= 72/8.
If the investment return is 10%, it will take 7.2 years to double the amount.
This rule will also help you make an estimate of the impact of inflation on your future life goals. For example, if higher education cost is Rs 25 lakh today how much money you will need after 15 years if annual inflation is 5%?
When we apply Rule of 72 and divide it by annual inflation rate of 5%, then the result that we get is 14.4. So, it will take 14.4 years for cost to double. So after 15 years, the higher education cost will be a little above Rs 50 lakh.
In case of 6% inflation, the cost will double in 12 years, while in case of 4% inflation, it will double in 18 years.
4% withdrawal rule or 25 times retirement corpus rule
The rule takes into account the corpus you require at retirement and the withdrawal of it. You first need to calculate the retirement corpus. For instance, if your expected annual expense in the first year of retirement is Rs 10 lakh, you would need a retirement corpus of Rs 2.5 crore, which is 25 times of the first year’s annual expense.
And then, as per the 4% withdrawal rule, if you withdraw 4% annually from your corpus in the first year, while taking care of inflation each year, you can sustain the retirement corpus for a lifetime, no matter how long it is.
If you withdraw 4% annually from this corpus and the corpus is growing at a higher rate than the withdrawal, the corpus can continue for your life and keep growing.
50-30-20 rule
The rule was made popular by US Senator Elizabeth Warren in her book ‘All Your Worth: The Ultimate Lifetime Money Plan’. The rule says that you should divide your income into 3 categories-50%- needs (groceries, rent, emi, etc)
30%- wants (entertainment, vacations, etc)
20%- savings (investment in equity, FD, mutual funds, etc)
As per this rule, you need to differentiate between need and wants and allocate funds accordingly. This rule puts emphasis on saving 20% of your income and investing it for future goals. However, you can go beyond this 20% saving target with some control on wants related expenses.
Equity appetite (exposure) - 100 minus age rule
Equities are known to deliver high returns in the long run. However, these are also considered to be highly volatile in the short term and hence considered a risky asset. To be financially prudent in one’s investment, one should not take excessive exposure to risky asset. In other words, only a limited part of portfolio should be invested in equities. To take the decision in a simple way, there is a prominent rule for the portfolio asset allocation to equity.As per the rule, if you want to know the equity proportion required for your portfolio, then subtract your age from 100.
If your age is 35 years, you can invest 65% in equity.
100-35= 65% equity
The rest 35% can be invested in safer assets.
As your age increases, you need to decrease the equity proportion and increase the safer asset proportion.
40% EMI rule
This rule helps you in knowing your borrowing limitations. The rule says that the EMIs of all your loans should not be more than 40% of your monthly income. It will help you maintain your other expenses.
If your monthly income is Rs 60,000, your EMIs should not be more than Rs 24,000, which is 40% of Rs 60,000.
Similarly, if your income is Rs 1 lakh, EMIs should not be more than Rs 40,000.
This rule prevents you from falling into debt trap by knowing your limit up to which you can service your debt without putting your finances under stress.
10X income life insurance rule
Many people know the importance of life insurance, but they don’t know the minimum insurance cover they require.
The rule says that if you want to know the minimum insurance cover you need to have in your life, then multiply your annual income by 10.
If your annual income is Rs 10 lakh, your minimum insurance amount should be= Rs 10 lakhX10= Rs 1 crore
However, it is better to go beyond minimum, and it is advised by experts that ideally you should have a life cover of 15 times of your annual income.
3X emergency fund rule
We can face many financial emergencies in our life. These can be job loss, medical emergency, unavoidable home repair, etc. For those emergency situations, we need to have an emergency fund which should be readily accessible without any delay. In absence of the emergency fund, you may have to go for premature liquidation of your long-term investments.
The 3X emergency rule says that one needs to have an emergency fund that is at least 3 times their monthly income.
If you earn Rs 60,000 a month, the minimum emergency fund you need is Rs 1.8 lakh.
However, it is better to go beyond minimum and ideally one should have an emergency fund equal to six times of your monthly expenses.
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