A thumb rule is an easy way of simplifying your financial decisions, especially when you want to avoid doing maths for your financial planning. Although it may help you in day to day finances, some of them oversimplifies the complexities attached to your long term financial prospects. Retirement Planning is one such goal where a thumb rule will not work as it requires a fairly long term investments with regular review and monitoring. In fact it requires a lot of math to get near to the correct picture. Similarly, there may be other aspects of your financial life where you cannot make decisions based on a thumb rule. But still, some of them have a good significance in a household financial decision-making.
Here are 10 rule of thumbs related to savings & investments :
1.Rule of 72: This is a common used thumb rule to know in how many years your investment will get doubled. You simply divide 72 by the returns you are receiving to get the desired figure. So if you are expect 8% rate of return on your investment then in 72/8=9 years your investment will get doubled.
2. Rule of 69– A more accurate version of the above thumb rule. Divide 69 by the rate of return and add .35 to it. The result is the numbers of years your money will get doubled. So if you achieve 8% returns the doubling happens in 8.62+.35 i.e. 8.97 years.
3. Rule of 70– Inflation impacts your investments and so the value will decrease in future. By using this thumb rule you can know the impact of inflation i.e. in how much time your investment value will be reduced to half. Divide 70 by the inflation you expect. So if you assume inflation of 6% then in 70/6 = 11.66 years value of your investment will reduced to half.
4. Rule of 114 – This rule tells you in how many years you money will get tripled. So for 8% rate of return on your investments, in 114/8= 14.25 years you can expect your value to be tripled.
5. Rule of 144 – Not so common but in line with above it tells you the years your money will take to quadruple. So at 8% rate of return the money reaches the figure in 144/8= 18 years.
6. 100 minus your age– A very common thumb rule used by even agents and advisors for allocating exposure to equities is 100 minus age. So as per this rule if you are 25 then 75% should be in equities while if you reach 50 your exposure to equity should be limited to 50% of your investment portfolio. However, this thumb rule fails to account the unique financial situation and so will not work in all scenarios.
7. Pay Yourself First– Before you can reach for spending money, 10% of your net income should be saved for your long term goals such as retirement. An effective thumb rule which states that you earn to save for yourself and it should be the first priority.
4.10,5,3 Rule– A handy thumb rule which states that you should expect 10% from equities, 5% from bonds and 3% from cash. But these are far more conservative return then what you actually achieve and so many of us will not agree with it.
9. Emergency Fund Rule– Its necessary to plan for emergencies and most planners/advisors will guide you to have 3-6 month emergency fund. This is a very common thumb rule being used more effectively.
10. 4% Withdrawal Rule– This rule is reasonable for retirement withdrawals which states that you withdraw every year 4% of your investment portfolio with increasing it by inflation rate at every withdrawal. So if your invested portfolio is Rs 1 lakh then in first year you withdraw 4% of your invested portfolio i.e. Rs 4000 but next year you withdraw 4000 + 6% (240) = Rs 4240. This way you protect your principal by reducing the impact of inflation. However, the actual withdrawal rate will depend on your retirement needs and the performance of your portfolio.
Some of the above thumb rules may not apply to your financial situation and so may not always work. Rule like 100 minus your age may be relevant to a person nearing retirement but may not suit a young investor who has a long term goal of wealth accumulation. But emergency fund rule and pay yourself first are the rules which relates more to protecting your financial health in case of emergencies and ensuring you do not miss saving for your long term goal. Both these rules help your financials in any situation of your lifecycle.
Thumb rules are easy to adopt as it involves an elementary math. But before following any of them it’s wiser to have a comprehensive view and then take a decision.
Have you been following any of these thumb rule?How it has helped you in your financial decisions? Did you planned for any long term goal with a thumb rule?
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