Essential Financial Rules

In the complex world of personal finance, having a set of guiding principles can be incredibly helpful. These financial rules of thumb can serve as quick mental shortcuts to help you make better financial decisions. While they shouldn’t be followed blindly, they provide a great starting point for managing your money effectively. Let’s explore 11 essential financial rules that everyone should know.

1. Rule of 72 (Double Your Money)

The Rule of 72 is a quick way to estimate how long it will take for your investment to double at a given interest rate. Simply divide 72 by the annual rate of return. For example, if you’re earning 8% on your investment, it will take approximately 9 years (72 ÷ 8 = 9) for your money to double.

2. Rule of 70 (Inflation Adjustment)

Similar to the Rule of 72, the Rule of 70 helps you understand the impact of inflation on your money’s purchasing power. Divide 70 by the current inflation rate to see how long it takes for your money’s value to halve. For instance, if inflation is at 7%, your money’s purchasing power will be cut in half in about 10 years (70 ÷ 7 = 10).

3. 4% Withdrawal Rule

This rule suggests that retirees can safely withdraw 4% of their retirement savings each year without running out of money. To use this rule, calculate your required corpus by multiplying your estimated annual expenses by 25. For example, if you expect to need ₹500,000 annually in retirement, aim for a corpus of ₹12,500,000 (500,000 × 25).

4. 100 Minus Age Rule

This rule helps with asset allocation based on your age. Subtract your age from 100 to determine the percentage of your portfolio that should be in equities. For instance, if you’re 30, you might allocate 70% (100 - 30) to equities and 30% to debt. As you age, you gradually shift towards more conservative investments.

5. 10, 5, 3 Rule

This rule sets reasonable return expectations for different types of investments:

• 10% - Expected return from equity or equity mutual funds
• 5% - Expected return from debt instruments (like fixed deposits)
• 3% - Expected return from savings accounts

6. 50-30-20 Rule

This budgeting rule suggests allocating your after-tax income as follows:

• 50% for needs (rent, groceries, utilities)
• 30% for wants (entertainment, dining out, hobbies)
• 20% for savings and debt repayment

7. 3X Emergency Rule

Always keep at least three times your monthly income in an easily accessible emergency fund. This provides a safety net for unexpected expenses or income loss. Some experts even recommend having up to six months of expenses saved.

8. 40% EMI Rule

Your total EMIs (Equated Monthly Installments) should not exceed 40% of your monthly income. This rule helps prevent overextension on loans and ensures you have enough income for other expenses and savings.

9. Life Insurance Rule

A good rule of thumb for life insurance coverage is to have a sum assured that’s 20 times your annual income. This ensures your dependents are financially secure if something happens to you.

10. Rule of 144

This rule helps estimate how long it will take to double your money when investing via SIP (Systematic Investment Plan). Divide 144 by the expected annual return rate. For example, if you expect a 12% return, your SIP investment will double in about 12 years (144 ÷ 12 = 12).

11. Revolving Credit Formula

To understand the true cost of revolving credit (like credit cards), use this formula: (1 + monthly interest rate)^12 - 1. For instance, if a credit card charges 3% monthly interest, the annual cost is actually 42.6% [(1 + 0.03)^12 - 1 = 0.426].

Conclusion

While these rules provide valuable guidelines, remember that personal finance is, well, personal. Your specific situation may require adjustments to these rules. Always consider your unique circumstances, risk tolerance, and long-term goals when making financial decisions. When in doubt, consult with a qualified financial advisor who can provide personalized advice tailored to your needs. Remember, the journey to financial well-being is a marathon, not a sprint. Start applying these rules today, and you’ll be on your way to a more secure financial future.

Cheers,

Sim