Personal finance is often overlooked as a critical subject in today’s society. While people tend to focus on their professional development and personal growth, they often neglect their financial well-being. This is unfortunate, as personal finance is a fundamental aspect of life that impacts our day-to-day decisions, our long-term goals, and our overall quality of life.
The lack of financial literacy and knowledge can lead to poor financial decisions, debt, and financial stress. In today’s fast-paced world, where credit is easily available and advertisements encourage us to spend more than we earn, it’s more important than ever to have a solid understanding of personal finance. Here are some important thumb rules pertaining to personal finance which are worth considering while planning your finances.
- Rules for Investment:
- 100 minus age rule: According to this rule, you should subtract your age from 100 to determine the percentage of your portfolio that should be invested in stocks. For example, if you are 30 years old, you would invest 70% of your portfolio in stocks and 30% in bonds.
For example, if you are 30 years old, you would invest 70% of your portfolio in stocks and 30% in bonds. - 120 minus age rule: This rule is similar to the 100 minus age rule, but it suggests subtracting your age from 120 instead of 100. This results in a higher percentage of your portfolio allocated to stocks. For example, if you are 30 years old, you would invest 90% of your portfolio in stocks and 10% in bonds.
- Rule of 72: This rule can help estimate how long it will take for your money to double at a given interest rate. Simply divide 72 by the interest rate to get the approximate number of years it will take for your investment to double.
- 100 minus age rule: According to this rule, you should subtract your age from 100 to determine the percentage of your portfolio that should be invested in stocks. For example, if you are 30 years old, you would invest 70% of your portfolio in stocks and 30% in bonds.
- Rule for Savings:
- 50/30/20 rule: This rule suggests that 50% of your after-tax income should be spent on essential expenses such as housing, utilities, and food, 30% should be spent on discretionary expenses such as entertainment and travel, and 20% should be saved or invested for future goals such as retirement or emergencies.
- 6 months rule for an emergency fund: This rule suggests that you should have enough money saved to cover upto 6 months’ worth of living expenses in case of an emergency such as job loss or unexpected medical expenses.
- Rule for Housing Affordability:
- 28/36 rule : This rule suggests that you should spend no more than 28% of your gross monthly income on housing expenses such as rent or mortgage payments, and no more than 36% on total debt payments including housing, car loans, and credit card debt.
For example, if your gross monthly income is $5,000, you should aim to spend no more than $1,400 on housing expenses and no more than $1,800 on total monthly debt payments.
- 28/36 rule : This rule suggests that you should spend no more than 28% of your gross monthly income on housing expenses such as rent or mortgage payments, and no more than 36% on total debt payments including housing, car loans, and credit card debt.
- Rules for Insurance Cover:
- Life Insurance: In developed economies, the thumb rule is that one needs to have an insurance cover equivalent to 7 to 10 times of annual income. Experts believe that in an economy like India, Brazil where inflation could be higher than developed economies, it is better to have a cover equivalent of 10 to 15 times the annual income plus the outstanding liabilities.
For example, if an Indian person has an annual income of Rs 500,000 and outstanding home loan of Rs 10 Million then the adequate insurance cover would be anywhere between Rs 5 Million and Rs 7.5 Million plus liabilities (Rs 10 Million) i.e. Rs 15-17.5 Million.
This will ensure that your loved ones are financially protected in case of your untimely death. - Health Insurance: Your health insurance coverage should be at least 5-10 times your annual income. For example, if your annual income is $50,000, your health insurance coverage should be at least $250,000 to $500,000. This will ensure that you are adequately covered for medical expenses in case of an illness or injury.
If you have a family, you may need to consider additional coverage for your spouse and children. In this case, you may need to increase your coverage to at least 10-12 times your annual income. - Disability Insurance: A good rule of thumb is to have disability insurance coverage that is equal to 50-70% of your current income.
For example, if you earn $50,000 per year, your disability insurance coverage should be between $25,000 to $35,000 per year. This will provide you with a steady source of income in case you are unable to work due to a disability.
If you have a family or dependents who rely on your income, you may need to consider additional coverage. A good thumb rule is to increase your coverage to at least 100% of your current income, or more, to ensure that your loved ones are financially protected in case of a disability.
- Life Insurance: In developed economies, the thumb rule is that one needs to have an insurance cover equivalent to 7 to 10 times of annual income. Experts believe that in an economy like India, Brazil where inflation could be higher than developed economies, it is better to have a cover equivalent of 10 to 15 times the annual income plus the outstanding liabilities.
- Rules for Retirement Planning
- 20 times Rule: This rule suggests that you should save enough money to have 20 times your annual expenses in retirement savings to be able to retire comfortably.
- The 4% rule: This thumb rule for retirement planning suggests you can safely withdraw 4% of your retirement savings in the first year of retirement, and adjust that amount for inflation in subsequent years without running out of money for at least 30 years.
For example, if you have $1 million in retirement savings, you could withdraw $40,000 (4% of $1 million) in the first year of retirement. If inflation is 2%, you would withdraw $40,800 in the second year, and so on.
This rule assumes that your retirement savings are invested in a mix of stocks and bonds and that your investment returns will be at least equal to the rate of inflation over time.
- 20 times Rule: This rule suggests that you should save enough money to have 20 times your annual expenses in retirement savings to be able to retire comfortably.
It’s important to note that these thumb rules are just guidelines, and the actual coverage you need may vary based on your individual circumstances.
Keep Saving, Keep Investing!
