PERSONAL FINANCE RULES: Each Investor must know
Posted On June 16, 2019
Investing is an art.
Investment depends on few fundamental principals . Each investor should know these principles to protect and enhance his/her cap capital.
Please list out these principles and always remember before investing.
1) Rule of 72
This thumb rule is used to estimate the number of years it would take to double your investment given your expected rate of return.
No. of years to double = 72 / rate of return
With the current fixed deposit rates in Indian banks for long term deposits hovering around 6–7%, it would take approximately 12 years to double your money (72 / 6).
If 100 is invested for 12 years at 6% then we get the future value as 201.22.
This rule can also be used for reverse calculating the rate of interest applicable for doubling your money for a period.
To double your money in 6 years. To evaluate the offer you wish to find the rate of return promised.
Return % = 72 / 6 years = 12%.
2) Rule of 114
This rule is used to estimate the number of years it would take to triple your amount given the expected rate of return.
No. of years to triple = 114 / rate of return
Using the same data as rule of 72, No. of years to triple would be 114 / 6 = 19 years.
3) Rule of 144
This rule is used to estimate the number of years it would take to quadruple (4 times) the amount given the expected rate of return
No. of years to quadraple = 144 / rate of return
Using the same data as rule of 72, No. of years to triple would be 144 / 6 = 24 years.
4) House Affordability rule
This thumb rule helps the home buyer decide on the maximum amount they can spend on buying a house or property. It would be wise to keep the purchase price of the house within this amount.
Maximum value of house = 2.5 X Annual Income.
Let us say the annual income is 20 lacs (20,00,000). The maximum value of the house should be less than 50 lacs (20 lacs X 2.5)
There are variations of this rule where the suggested range varies between 2X to 3X of the Annual income. Still we get a fair picture of the possible range of values (60 lacs to 90 lacs). In the event of the buyer liking a property worth say 1.5 crores (15 million) then it is obvious that the price is above the prudently acceptable affordability range.
5) 28% Housing EMI rule
This rule talks of the maximum amount one can budget for housing loan monthly EMI payments.
Everyone loves to own a big house from a reputed builder in a posh locality. The tax rebates on housing loan payments gives further incentives to a prospective home buyer to go for bigger houses. This rules helps us with a reality check.
Maximum Monthly Home loan EMI = 28% of Gross monthly income
If you make 1 lac (1,00,000) a month then your monthly home loan EMI should not exceed 28,000.
6) 36% Debt rule
Assuming you are a wonderful customer for your bank having availed housing loan, vehicle loan and personal loan then this rule states the maximum amount you can spend by way of loan / debt payments
Maximum Monthly debt (EMI) payments = 36% of Gross monthly income
If you make 1 lac (1,00,000) a month then the total of all your monthly loan EMI’s should not exceed 36,000.
7) Emergency Fund rule
This rule talks of the amount a person needs to set aside in a liquid asset (cash, savings account, short term fixed deposit) to face any emergencies like loss of employment, illness, business downturn etc.
Emergency Fund = 6 X Monthly household expenses*
*Household expenses also includes the monthly loan EMI payments
Let us say your monthly commitments and expenses add upto 50,000 then your emergency fund should be ideally 300,000 (3 lacs).
There are variations ranging from 3X for people starting their career to 10X for the conservatives. Take your pick
8) 10% saving rule
Saving for a rainy day is a practice followed from the early days of human civilization. This rule talks of the amount we need to save to build our retirement nest egg.
Minimum monthly savings = 10% of Gross monthly income.
Saving 10,000 if you are making 1 lac is the minimum suggested amount. Ideally the percentage should be above 20% if you wish to have a decent corpus and a decent lifestyle. One crucial thing also is to start saving early.
9) 48 Hour Rule
This thumb rule is useful against impulse purchases. The rule states that when you have a strong urge to make an impulse purchase then postpone the purchase for 48 hours.
If even after 48 hours the urge still remains then go ahead with the purchase. In most cases it has been found that the urge is no more there. This also prevents piling on debt / credit card dues because of impulse purchases.
10) 1% Windfall rule
This is a very important rule worth remembering. This talks of what needs to be done in case you hit a jackpot say, lottery / inheritance / house sale / multi-bagger stock picks. This rule prevents you from taking impulse decisions like splurging on a new car or house and thereby losing the fortune.
In case of a windfall take out 1% of the proceeds after taxes and treat yourself. The rest of the money to be set aside in a bank account to be left untouched for at least 6 months
Some studies have shown that 50% of the windfall is lost in relatively short period of time and also that 70% of the fortune won through lottery is lost within 3 years. So this rule becomes very crucial to preserve the windfall from rapidly eroding.
Also when the news that you have hit jackpot spreads, you will have a sudden spurt in the number of friend requests as well as visits from relatives you have not seen for years. These new characters will also most likely disappear the moment the bounty is exhausted. To
If you get an inheritance of 1 crore (10 million) then spend 1% or 1,00,000 on yourself and your family. The remaining 99,00,000 to be set aside in bank account for 6 months.
11) Expected Net worth Rule (Millionaire Next door formula)
This rule is used to arrive at your expected net worth based on your income and age. It was published by Thomas Stanley and gained popularity with the book “The millionaire Next door”.
10% X Age X Gross Annual Income (Pre-tax) = Expected Net worth
For a 40 year old with an annual income of INR 25,00,000.
Expected Net worth = 10% X 40 X 25,00,000 = 100,00,000 ( 1 crore or 10 million)
As with every thumb rule there are some limitations. For e.g. applicability for young people starting their career.
12 ) Retirement Corpus rule
This is another rule which talks of the retirement corpus amount you need to accumulate before calling it quits to have a peaceful and financially stress free retirement life.
Retirement corpus = 20 X Gross Annual Income
Let us say your annual income is 25 lacs ( 25,00,000) then your retirement corpus should atleast be 5 crores ( 25 lacs X 20) to maintain your current lifestyle
There are variations of this rule where financial planners’ advice up to 30X of annual income considering the increasing life expectancy and inflation.
As Mae West said “Too much of a good thing can be wonderful”. Aim to accumulate at least 20X. If you can do anything more, then it’s wonderful.
13) 100 minus age rule (or Bond portion equals age rule)
This thumb rule tell an investor what portion of his portfolio should be in equities. The logic is that as an investor gets older, their risk taking appetite reduces and hence would not prefer large swings in portfolio value. This rule was made even more popular when John Bogle said
“My favorite rule of thumb is (roughly) to hold a bond position equal to your age – 20 percent when you are 20, 70 percent when you’re 70, and so on – or maybe even your age minus 10 percent.”
Percentage of portfolio in equities = (100 – your age)
If you are 40 years old then the suggested percentage of allocation to equities would be 60% (100 – 40). An alternate way to put this is that the percentage of allocation to bonds would be 40% (equals your age)
As with every thumb rule there are different versions out there with some experts substituting 100 with 110 or even up to 140. For all practical purposes an investor can stick with the original rule of 100.