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Thumb Rules Of Personal Finance

what are the thumb rules of personal finance

Thumb Rules Of Personal Finance

Thumb rules are the more powerful advice that we can get in our day-to-day life when it comes to personal finance. Here are some very useful personal finance rules of thumb which I am sharing with you all today to help you get ahead financially, especially if you are new to financial planning.

Let’s explore each of them one by one:

Rule of 72 

This rule states that you can divide the number 72 by whatever return you are getting to see how long it would take for your investment to double.

For example, if your fixed deposit earns an annual interest of 8%, it will take 9 years for your money to double! i.e.72/8 = 9 years. 

Pay yourself first

It’s very important to set aside your savings every month before you use the money for other expenses. Always pay yourself first before anything else.

The standard rule of thumb says that you must save at least 10% of your income. In this period of consistently increasing inflation, I believe a better goal would be to aim for 20% savings of your monthly income.

And, if you are young, then you can follow this thumb rule - Save 10% of your income for your basic needs, 15% for your comfort, and 20% to escape wherever you want.

50/20/30 Rule For Savings

Most popular rule for breaking down your budget is 50-30-20 rule which says, put... 

  • 50% of your income for basic necessities, like housing, groceries and bills. 
  • 20% should go towards your financial goals, like paying off debt or saving for retirement. 
  • And the remaining 30% of your income can be allocated to refreshment and want, like dining, travel or entertainment.
This particular idea is to create outflow buckets for better control. You can change the percentage according to your age, circumstances, etc.

10-Year Rule

This rule helps you to decide buy new vs. used. If you want to maximize your car's value, you should either buy used, or buy new and drive the car for minimum ten years.

20/4/10 Rule For Your Car Loan

Whether your desire is to buy a Mercedes, BMW, Audi or Tata, Mahindra, Maruti Suzuki, Car Loans are the popular choice when it comes to funding your dream car. However, applying for Car Loan when buying a new car can leave you in a bit of a pickle, especially if a financial crisis strikes before it is paid off completely.

This is when comes the 20/4/10 rule in use. If you want to make the most of the car and the loan, this simple rule will help you keep your finances under control when you’re buying a new car.

This rule states that you should save at least 

  • 20% for the down payment amount.
  • Finance your vehicle for no more than 4 years. 
  • And, keep total monthly vehicle expenses including principal, interest, and insurance under 10% of your gross income.

Let’s explore each of these components in detail:

20: This is the percentage amount you need to make as a down-payment towards the loan. This figure ensures that you pay a sufficient amount initially and thereby decreases the total cost of your loan.

4: It refers to the tenure of the Car Loan. There are lenders out there who allow you to borrow for a tenure of 7 years as well, but that works more in the lender’s favor than yours. After all, the longer the loan tenure, the more interest on loan you pay!

10: Ideally, this one is the percentage of your monthly salary that should go towards the monthly installment of the car. The lower the percentage, the better it will be, but anything above that could easily put you in a debt trap.

Adequate Life Insurance

Ahhh! This one is the most important factor which I give the top priority in my life. And you too must consider it as the most important and most required necessity in life after 'Roti, Kapda aur Makaan'. Life Insurance is a risk management tool that makes sure your financial dependents can set up an alternative income stream in the unfortunate event of your death. It can help them maintain their lifestyles for a reasonable period and meet their financial goals even in your absence. If you’re uninsured or under insured, you are effectively exposing your dependents to the high risk of not having enough financial back up to fulfill those objectives.

However, determining how much Life Insurance cover is adequate can be a little tricky. So, going with thumb rule, one should have a life cover that is at least 10 times your annual income.  So, if you’re earning Rs. 10 lakhs annually, your coverage should at least be Rs. 1 crore.

However, do keep in mind that Life Insurance needs are governed by many factors like your age, income, assets, liabilities etc., and consequently the one-size-fits-all approach doesn’t always work. Also, don’t forget to review and upgrade your life insurance cover every few years since needs tend to differ at different stages of life.

Adequate Health Insurance

After life insurance, comes health insurance which is very much necessary today in everyone's life. In case of any medical emergency it will be smartness to use your family floater health insurance cover rather than loosing all your savings. 

In order to save your savings eaten up by any medical emergency take adequate family floater health insurance plan today itself.

Home Loan

Congratulations! If you are planning to buy a house of your own! Although taking a Home Loan is now easier than ever before, don’t forget that a Home Loan is a long-term commitment and you need to be extra cautious when applying for one.

Thumb Rule Says That... 

Your monthly Home Loan EMIs should always be less than 30% of your monthly income. 

For example, if you are earning Rs. 1,00,000 per month, then your monthly EMIs should not exceed more than Rs. 30,000.

Also, if you have other EMI obligations such as a Car Loan or a Personal Loan, your combined EMIs should ideally be less than 50% of your monthly income. As long as you stick to this rule, there’s no need to worry about high Home Loan EMIs that could put you in a debt-trap.

To ease out the whole process of getting a Home Loan, there are a few online tools that could help you find the best deal and make the process more convenient and stress-free. Don’t forget to check them out before applying for your Home Loan. Go and get your Dream Home!

Emergency Fund

Whether it’s meeting routine household expenses or your commitment towards EMIs, certain cash outflows are completely unavoidable. An emergency fund is not aimed at meeting your planned goals but should act as a safety net.

Although there’s no fixed rule on how much emergency cash one should keep in his/her savings kitty, it is advisable that an amount equivalent of at least 3 to 6 months’ worth of household expenses should be in one’s emergency fund to help you handle financial emergencies with no stress.

Following these thumb rules will help you make best decisions about your financial future. But remember, they only provide a general direction and may not necessarily give you the exact picture. So, when in doubt, it’s always a good decision to consult a reputed financial expert to plan your finances well.

Now that you’re all set to take the road towards financial planning, go ahead and start investing for a better and secure future.

Stock Market

Know your risk tolerance ‘before’ you begin investing. The time to decide how much you can afford to lose in the stock market is before a crash, not after one.

Asset Allocation

The widely regarded asset allocation rule of thumb is to have X% of your portfolio invested in stocks, where X is equal to 100 minus your age with the rest invested in lower-risk investments like bonds. I believe this is an incorrect way to look at things.

A better way to look at asset allocation is to first answer this question - “Am I a stock or a bond?”

First understand yourself, your life and your career.

You are a bond if you have a stable job that is unaffected by the volatility of the stock markets, and you have many years left to work.

On the other hand, you are a stock if you have little years of work ahead of you, or if you work in a volatile and unpredictable field that could decline quickly with little notice (like the stock markets itself!).

So if you are a ‘bond’, have a larger part (say around 60-70%) of your portfolio in stocks to balance it out. And if you are a ‘stock’, tilt your portfolio in favor of bonds (or similar instruments).

Credit Cards:

Cut usage of your credit cards. If you’re not willing to buy a thing if you had cash, please don’t buy it just because you have a credit card.

If you get a windfall, use 1-2% to treat yourself. Put the rest in a safe place that will earn you interest and ignore it for six months. Allow the initial emotion to pass. Get over the initial urge to spend the money on a big house or a bigger car. Live your life as you had before. After you’ve had time to think about it, make your decisions.

Rules of thumb can be a good approximate guideline for decisions, and there are tons of money rules that aim to get your finances on track. While everyone's situation is different, these serve as a good starting point.

I thought to put together a list of some solid, useful rules of thumb to follow. However, since everyone's situation is not same, I have also included some scenarios in which these rules are worth reworking to your needs.

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Post a Comment

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