Source/Contribution by : NJ Publications
Ever wondered how much should you invest in equities? In what time will your money double? Most of our money related questions often have complex answers which are boring and beyond comprehension for most of us. Well, now you can take a break from the calculators and take a look at a few quick thumb rules, often used by financial planners /advisors, to answer our questions. These thumb rules are interesting, easy calculation tips which we can use in our daily lives. But we also have to be careful as the results are often approximate and may not be 'exact' answers we are looking for. It will be up to you and your financial planner /advisor to help you take the right wealth management decisions.
When Will Your Money Multiply? The Compounding Rules Of 72 And 114.
The Rule of 72 tells us in how much time will our money double given a rate of return or interest. Simply divide 72 with your annualised returns to arrive at the number of years. For eg., if the interest rate is 8%, then it will take approximately (72/8 = 9) nine years to double your money. Turn the corner and it can also help you know the required rate of return to double your money in a given time. For eg., if the time available is 6 years, the returns required to double the money will be (72/6 = 12) 12% yearly. Likewise, there is also a Rule of 114 where 114 is used in place of 72 to triple (3x) the money.
How Much Will My Money Worth In Future? The Rule Of 70.
Inflation is one important thing to keep in mind when planning for future. But calculating the effect of inflation is not easy for most of us. This rule can be an useful tool for predicting your future buying power. Simply divide 70 by the current inflation rate to find the approximate time your money will take to reduce to half its' present value. For eg., inflation of 7% will reduce the 'value' of your money to 'half' in (70/7 = 10) 10 years.
How Much Should You Invest In Equities? 100 Minus Your Age Rule.
One of the basic ideas while investing in equities is to reduce the exposure as you grow older. But, apart from age, there are also many other factors affecting your asset allocation which makes risk profiling an important exercise. For the rest of us, this rule easily gives an idea on the extent of equity exposure, considering the age. For eg., if your age is 40, your equity exposure should be at (100-40 = 60) 60%. The balance would be invested in debt and other safer asset classes. Note that this old rule is contested by many experts today who argue that 100 be replaced by 110 or 120 or even higher considering the need for wealth creation, longer life expectancy and low debt returns.
Can I Afford That New Car? The 20/4/10 Rule Of Buying Vehicle.
This rule is used especially at the time of buying vehicles or similar assets. The rule says that while getting a loan for a vehicle, you should first put down at least 20% as the down-payment, the loan term should not be for more than 4 years and that your total monthly transportation costs (including EMIs) should not be over 10% of your income. This rule can thus also help you know whether you can trully afford to buy the vehicle of your choice.
How Much Should I Withdraw To Keep My Principal Intact? The Four Percent Rule.
This rule is used very often in retirement planning where the idea is to arrive at a withdrawal figure every year that will keep the retirement kitty intact while you are not generating any other income. The rule says that we can withdraw 4% annually from the outstanding balance amount to keep the absolute value of the retirement kitty (or any principal) intact. While there are many faults and misses in this assumption, like the rate of return, inflation, life expectancy, etc., the underlying idea is not entirely lost. Some experts say that the actual figure should be less than 4%, preferably 3%. The lesser the figure the better it is as it can ensure you do not run out of your retirement kitty any time soon.
How Much Should I Earn After Retirement? The 80% Replacement Income Rule:
Many experts believe that we should aim for replacement of 80% of our income after retirement to live comfortably. This presumably takes care of the reduced expenses on one hand while maintaining the living standards on the other hand. This income would be generated from retirement kitty investments and/or through income earning activities. Some experts believe that this figure can be bit lower, say at 75%. Note that having a big retirement kitty would increasingly help in reducing the need for non-investment income after retirement.
Pay Yourself First Rule:
This is a simple yet very important rule used in financial planning, especially retirement planning. The rule requires us to save for our own future (read retirement) first before anything else. The idea is to make an automatic arrangement from your bank account every month so that, the money is auto-deducted first every month after your receive your cash inflow, like salary. The process of automatic routing is said to be like 'paying yourself first' since money is deducted before other expenses are incurred.
Other Common Rules:
- The 10% Savings Rule: Most experts believe that the savings rate should be a minimum of 10% of your gross household income. A better goal is to aim higher. Another popular rule is to start saving 10% for meeting basic needs, 15% for comfort and 20% for freedom when you are young.
- The 3 Month Emergency Fund Rule: The idea is to have at least 3 months and going up to 6 months, of living expenses as emergency fund in addition to your savings for other goals. This of course depends on the nature of our work, risks and possibilities of finding new source of income soon.
- The 6 Times Life Cover Rule: This rule simply says that your life insurance policy should be at least 6 times of your total household income. If the 6 times would seems inadequate, note that we are well advised to have a higher cover.
- The 20% Down-payment, Two Times Home Loan Rule: This rule says that while buying a home, we should put down 20% as down-payment and avoid taking a loan over 2 times of our total household income. If we cannot afford the 20% down-payment rule, it probably means that we cannot afford that home itself.
- 20 times Income Rule For Retirement Kitty: How much retirement kitty you will need is a big question. There are many calculations available but this simple rule says that it is 20x of your gross total income at the time of retirement.
- Pay Highest Interest Rate Debt first: This rule points out which loan has to be repaid on priority first – it is the one that carries the highest rate of interest. Usually, the order would be credit card first, then bank overdraft, personal loan, vehicle loan and lastly home loans.
- Don't Take An Education Loan More Than The Expected First Year Salary: With rising education costs, this one rule can help decide whether to pursue an education course on loan or not. Following this rule will help avoid the struggle to repay loan after the education is completed. Ever wondered how a wealthy person.