The thumb rule is required to plan for all financial decisions making for an individual in life. People want shortcuts in life and this is the reason that financial planning thumb rules have got space in everyone’s life.
The thumb rules are the basic financial guidelines that are required for every individual to make financial decisions. Having an understanding of these guidelines will help you to make financial decisions. Here in this article, we discuss the top 7 thumb rules for planning your finances.
- Making Asset allocation
- Plan for emergency funds
- Invest for retirement
- Insurance
- Affordable EMIs
- Buying an asset
- Multiply your investments
1. Making asset allocation decisions
Making asset allocation decisions is the most important and very common rule of thumb in investment. There are different categories for making investments according to age. This will differ from person to person according to age. According to the rule, the investment rule equity percentage in your portfolio has to be 100 less than your age.
In other words, the debt amount should be equal to your age. For instance, if the age of an individual is 30 years then you should be having 30% of debt investment and 70% in equity. This means that it should be having debt investments of up to 30% and 70% in equity.
Having this proportion will help you to manage your debts. It will give an idea of how you are managing your debts with the available owned funds. According to the age criteria, make the calculations and make your asset allocation decisions.
2. Plan for emergency funds
Emergency funds will help you when there is a sudden need for money. This could be for your medical expenses or any sudden financial requirements. One should have an emergency fund which is equal to 3 to 6 months of monthly expenses. Having a 3 months emergency fund is a basic requirement.
If you are working in a private sector and your job is unstable or you’re running a business and it is operating in dole drums then you should be having a higher range than 3 months of an emergency fund.
Do not use your emergency funds for day-to-day operations. The thumb rule for retired people is they should have emergency funds which should be equal to 1 year of expenses.
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3. Invest for retirement
Every individual who is planning for retirement has the basic question that is how much is the retirement fund to plan for? How much will I need to invest for in future? This principle works with an assumption that other things remain constant which means your health condition is good and you do not have any hereditary illness and other factors remain good.
You should be having 20 times of your income saved towards retirement and you should be planning for replacing 80% of your pre-retirement income. The retirement age is considered -60 years and the expected lifestyle is conservative.
The new generation is not planning to save for retirement. If you have just started and joined the workforce and you would like to have a simple lifestyle and retire at the age of 60 years then you can start saving 10 percent of your income towards retirement.
If you are planning to retire early then you should be saving 20 % of your income for retirement. If you are in your early 30s then save 10% on basic needs, 15% on your future comforts and others. Keep adding 5 % more to your basic needs and comforts if you’re planning for retirement from your 40’s.The earlier you plan for retirement the less burden you will feel.
4. Insurance
In the insurance, the sum assured should be 8 to 10 times of annual income. This rule can be used as an initial point. If you are in your 30s then you should have insurance that is 12 to 15 times your annual income and if you are in your 50s then you should be having insurance that would be 6 to 8 times your annual income.
The insurance investment does not consider your goals, your liabilities and other expenses. Health insurance would take care of your medical expenses and life insurance would take care of your dependents. The returns on insurance are not aimed to achieve your personal goals.
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5. Affordable EMIs
Financial experts suggest that you should not have EMIs which are more than 36% of gross monthly income. Having zero EMI is a stress-free life but in today’s generation for every asset, you plan to purchase EMI option is available. Though EMIs will reduce your burden to purchase assets it will also reduce your capacity to save income for the future.
Having only less than 36% of gross monthly income will put you on the safe side. When you are close to retirement it should be less than that. EMIs for those who are close to retirement should be less than 28% of gross income.
6. Buying an asset
The thumb rule for buying an asset is to think will it add value to your asset life. Buying a home will add value to your property as the value of the home increases. There is always price appreciation on the building’s land & property value. On the other hand, buying an asset like a car will add depreciation to the value of the car year after year.
If you have purchased a car today for AED 50,000 after 5 years due to depreciation and wear and tear the value of the car will be half the value of its purchase price. When you are buying an asset like a car then the value of the car should not be more than 50% of your annual income.
Follow the rule that your minimum down payment should be 20% and loan tenure should be 4 years and monthly EMI should not exceed 10 percent of your income.
7. Multiply your investments
Plan to multiply your money, the most common rule to multiply your money is to divide 72 by the rate of return then you will get the total number of years in which your investments will double. For instance, the annual expected rate of return is 12% then your income will double in six years as 72 divided by 12 will be 6.
If your rate of return is expected to be eight percent then it will take 9 years to double your investment. Similar to rule 72 there are other rules which can be used. To triple your investment money use rule 144 and apply the same formula.
Take away
Money making and multiplying is a skill that will depend on how much you spend and how much you save from your earnings. These financial rules will help you to understand financial basics, assist you in budgeting your money, making right decisions in savings and investments, managing your debts and insure for the future.
About the author
Vinay Kumar Goguru is a finance professional with more than 8 years of diverse experience as a researcher, instructor and Industry work experience with both public and private entities. Prior to MyMoneySouq, he spent 6 years in Berkadia, It's a commercial mortgage banking company. He has a "Doctoral Degree in Commerce" and two master's degrees with a specialization in Finance, one as Master of Commerce and other as Master of Business Administration. He has written several articles on personal finance, published by different International journals. He loves traveling, reading and writing is his passion. He has a dream of writing a book on his favorite finance topics.
