In today’s fast-paced world, people (especially the younger generation) seek shortcuts and simplified rules in almost all aspects of life. Money management is no exception.
The primary reason behind this could be the behavioral biases coming into play. Where, we prioritize short-term pleasures over long-term gains.
I frequently hear many young guys expressing their reluctance to get into the “complex and boring” process of financial planning, instead they keep asking for shortcuts.
Financial planning is a complex and personalized process, but the ultimate aim is to simplify the financial life. Though still, there are some general thumb rules that can help you streamline your money life. Read more: What is the Right Time to Start Financial Planning?
However, It’s important to note that these rules are very basic and are meant to be taken only as guidelines. These may not apply to everyone’s specific situation and seeking professional advice tailored to your specific circumstances is always a wise decision.
Here are a few common financial planning thumb rules that can be a good starting point:
Budgeting/Cash flow planning thumb rules:
- Income minus Savings = Expenses
This is the very first financial planning thumb rule that beginners or the young generation should understand. It is quite self-explanatory.
It simply means that, out of your income you should always save a certain percentage for your financial goals every month, before spending. Even if you don’t think of any financial goals at this point in time , still invest it for the long term. The equation should be this only and not the other way round. Also Read More: Budgeting – Be aware of your expenses
In other words, rather than spending first and then saving what is left out of your salary, you should save first and then spend the rest. It is the first step of financial discipline.
- 50-30-20 rule/ 30-30-30-10 rule
If you are new to budgeting or are confused about how to do it, this financial planning thumb rule can be of great help. It is a percentage based budgeting rule that defines how to allocate your spending across different categories. It says-
- 50% (Maximum) of your income should be spent towards your household expenses like- groceries, utilities, etc..
- 30% should go towards saving for short, medium and long-term financial goals.
- 20% should go towards discretionary spending including vacations, entertainment, shopping, etc.
There is another version of this rule too, which says-
- 30% of your income should go towards housing expenses, either rent or loan EMI.
- 30% may be spent towards your household expenses.
- 30% may be saved towards financial goals.
- 10% should go towards discretionary spending.
Budgeting based on these rules will not only help you structure out your cash flow but will also keep in control the urge to spend recklessly.
You may note a common thing in both the rules is …the Minimum savings are kept and maintained at 30%.
- Emergency fund rule:
Emergencies can knock at your door anytime and in any form, be it a sudden job loss, medical emergency, etc. So, it is crucial to have an emergency fund of adequate amount to tackle these situations and take care of the essential expenses. You should start with an emergency fund equal to 3 to 6 times monthly expenses and gradually increase it to up to 12 times your monthly expenses. Read More: Keeping emergency fund – first step in financial planning
Thumb Rules on Loans:
- 20/4/10 rule:
This financial planning thumb rule is applicable while taking a car loan. In this, 20 stands for the down payment percentage. It means, at least 20% of the cost of the car should be paid as down payment. 4 stands for loan tenure and 10 stands for the ideal percentage of income going towards loan EMI. It means, the tenure of the loan should be 4 years and the EMI should not be more than 10% of your income.
- 35/50 rule:
While taking a home loan, this financial planning thumb rule says that, your home loan EMI should not exceed 35% of your monthly income and the total EMI outgo on all the loans including the home loan should not be beyond 50% of the monthly income. This would help you save for other important financial goals.
However, banks at the time of giving home loan checks the other EMIs and generally will lend an amount on which the EMI shall not exceed 50% of your monthly inflow. Read more: Home Loan Repayment Strategy: Is it Better to Increase the EMI or Tenure?
Please note that it’s wise to look at all thumb rules in totality. Like if you are too much in loan and paying high EMIs equals 50% of your Income, you will either have to compromise on your Household expenses (which may get difficult), and thus you will find an easier way out in reduction of savings which is also not wise.
Retirement Thumb Rules:
- How much percentage of income should I save towards retirement?
If you are 25 years of age and want to retire at 60, you should start saving at least 10% of your income towards retirement. If you are planning to retire early, you should increase the initial investment to 20%. Overtime, as your income increases you should increase the savings too by 10% every year to reach your retirement goal.
- How much should my retirement corpus be?
If you want to retire at 60 with an assumed life expectancy of 80 years, your retirement corpus should be at least 25 to 30 times your annual income. Remember, this thumb rule is based on a very modest lifestyle considering basic expenses only. If you have lifestyle expenses too like- vacations, travel, hobbies, etc. your retirement corpus should be at least 50 times your annual income.
- The 4% withdrawal rule:
This rule of thumb states that, if you have saved at least 25 times of your annual income as your retirement corpus and annually withdraw 4% out of it, it is highly likely that the corpus will last for your entire post-retirement life (around 25 years).Read more: How to Manage Post Retirement Income flow – Bucketing strategy
Investment thumb rules:
- Rule of 72:
If you want to know that in how many years, money invested will double- simply divide the expected rate of return by 72. So, if you expect a 10% return on your investments, your investment value will double in almost 7 years.
Similar to this rule, there are two other rules as well:
- Rule of 114: This will help you know in how many years your investment will triple.
- Rule of 144: This will help you know in how many years your investment will quadruple or grow four times.
- Rule of 70:
This investment thumb rule will give you an estimate of the number of years when the purchasing power of your money will become half due to inflation. For example, if the average inflation in the economy is 7%, the purchasing power of Rs.100 today will become Rs.50 after 10 years.
Bonus Point:
- The Net Worth rule:
This thumb rule will help you understand whether you are doing well financially or not. As in with your income, expenses and savings, are you doing justice to your net worth.
Multiply your pre-tax annual income with your age and divide it by 10 – if your net worth is equal to or more than the number so obtained, you are doing well. Remember, you should exclude the inheritance (if any) you have received or is to be receivable while doing this estimation.
So, for instance, if you are 30 years of age and your pre-tax annual income is Rs.12,00,000, then your net worth should be at least Rs.36,00,000.
To Conclude:
Financial planning thumb rules are general guidelines that offer simple solutions to often complex personal finance problems.
Although these are based on some practical experience or empirical evidence and are helpful in making initial quick estimations, they cannot be accurate in every situation.
These thumb rules, if followed blindly, might give you a false estimate that might be very far from reality. So, it is imperative to take these with a pinch of salt.
All in all, personal finance is more “personal” than *finance”. Every individual has a unique financial situation and different needs and goals. “One-size fits all” approach does not work here. So, instead of making decisions only on the basis of financial planning thumb rules, it is always wise taking professional help for your comprehensive and customized financial planning. Read more: Financial Advisor in India – The Best for your Financial Planning?
