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Top 10 Financial Planning Rules of Thumb

September 6, 2011

In life people want shortcutsI think thats the reason rules of thumb find some place in oncelife. Thesefinancial planningrules of thumb are very basic & not at all full-proof as requirement

of 2 different people can never be same. They can just give you some idea but importantfinancial decisions should not be taken on basis of these. Editor of The Journal of Financial

Planning (US), once noted that Rules of thumb are for people who want to decide thingswithout thinking about them.But still it will be unfair to suggest ignoring all of them.

Saving & Investing rules of thumb

1. What should be my asset allocation or how much equity should I have?

This is the most common rule of thumb which is used in investment world. Rule says Equity

percentage in your portfolio should be equal to 100 minus your age or in other words debt shouldbe equal to your age. For eg if you are 30 you should have 30% of your investments in debt &

70% (100your age) in equity. This doesnt take care of risk appetite, risk tolerance or how faryour goals are.

2. How much emergency fund I should have?

Emergency Fund helps people in case of sudden loss of income, medical emergency etc. Thumb

rule says one should have emergency fund equal to 3 to 6 months of monthly expenses. You can

keep it at 3 month if you are a government servant but in case of private job or profession you

should keep it on the higher side of the range. Make sure you dont use this amo unt for day today needs/wants. For retired person emergency fund should be equal to 1 year of expense.

Retirement rules of thumb

3. How much money will I need in retirement or how much corpus I should build?

You should have 20 times your income saved for retirement and plan to replace 80 percent ofpre-retirement income. But here retirement means a retirement at age of 60 & life expectancy of

80 and a conservative lifestyle. But now things have changed & you would have

dream/planned lot of things for retirement.

4. How much I need to invest every month to achieve retirement goal?

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Indians are great savers sorry Indians were great savers. New generation is in some different

mood they would like to enjoy the present & have no idea about future. If you have just started towork & would like to have a very simple lifestyle & retirement at age of 60 you can do it with

saving (read investing)10% of your income. If you are planning for an early retirement start with

20% savings. Other rule says if you are in early 30s Save 10% for basics, 15% for comfort,

20% to escape. If you are late by decade add 5% more in each category.

Insurance rules of thumb

5. How much insurance should I have?

Here insurance means insurance. Rule says one should have sum assured of 8-10 times of his

yearly income. I think this rule is far from perfect but still can be used as starting point. This

does not take care of any of your goals, liabilities & even complete expenses. Some modified

version of this rule says that if you are in early 30s insurance should be 12-15 times of yourannual income & if you are in 50s take 6-8 times.

Loan/liability/home rules of thumb

6. How big should be my House?

The value of house should be equal to 2-3 times of your family annual income. So if you & your

spouse are earning total Rs 20 lakhyou should buy a house in Range of Rs 40-60 Lakh.

7. Maximum EMI that I can have?

Ideally 0 will be the best answer but few of the big assets like home require some loanto buy

them. Experts agree that your EMIs should not be more than 36% of Gross Monthly Income atany point of time. It should be even lesser when you are close to your retirement. If you want to

talk about home loan EMI, it should not be greater than 28% of your gross income. NowTENURE of loan is missing herefor tenure read No. 6 & 8 rules of thumb.

8. Rules of thumb for buying a car

This is one of the biggest purchases after your home. And this is depreciating asset todaymorning you purchase a car for Rs 10 lakh & by the evening it will be worth Rs 8-9 Lakh. After

5 years it will not be even of half value but still you keep buying cars regularly buy at 10, sell

at 4 & loose 6. (repeat the cycle) There are few rules that you can follow:

Value of car should not be more than 50% of the annual income of the owner. Purchase a used car or buy a new & use it for 10 years. While buying car with loan stick to 20/4/10Minimum 20% down payment, loan tenure

not more than 4 years & EMI should not be higher than 10% of your income.

Rate of return Rules of Thumb

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9. In how many years my amount will double?

Its a very simple & most common rule if you divide 72 by rate of return you will get the

number of years in which your money will double. For Eg. If you expect a rate of return of 12%

you money will double in 6 years (72/12=6) & what about if rate of return is 8%72/8=9 years.

This can also be used in reverse order at what rate your money will double in 5 years 72/5=14.4%

Rules similar torule of 72:

Rule of 114 & 144

These can help you in how many years your money will be triple (114) or quadruple (144) at

some rate of returns.

Rule of 70

You know it or not but inflation is your biggest enemy rule of 70 will tell you in how many

years value of money will be half. You just need to divide 70 with rate of inflation so if rate ofinflation is 7%70/7=10 years. So in 10 years your Rs 100 note will be worth Rs 50.

10. Rule 10/5/3

This is a US rule of thumb which says in long term you can get 10% return from equity, 5%

return from bonds (lets say FDs) & 3% from the t-bills (liquid fundsthese returns are more or

less close to the range of inflation). Indian economy is growing at some different pace & even

inflation numbers are different. Can we safely say if inflation is 6% (t-bill rates) we can get 8%

from the fixed deposits& 12% from the equity or in other words in long term equities willdeliver twice the return of inflation. Try combining Rule of 72 with this rule you will get some

amazing numbers.

Some time Rules of thumb will give you false sense of security or wrong guidance so take

them with pinch of salt.

If you heard of some other rules of thumb related to money/finance must share. Also share

your personal views/experience on any of the above rules.

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