Experts always throw some new thumb rules to follow from their research and experience. These thumb rules help us minimise our confusion and research time, so we can take action quickly.
Let’s discuss some of the most popular and helpful thumb rules in personal finance.
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Buckle up, here we go!
We all love shortcuts because often it is hard to start something. After all, it is overwhelming initially. So experts suggested some thumb rules as a shortcut, to begin with.
Remember, thumb rules are always meant to be used as a guide, not a rule.
But over time, it seems we all forgot this. So we are reminding you again that these rules are just guides to help start. They can give you some ideas, but we should not take important financial decisions on a standalone basis.
Also, most of these rules were suggested by experts from the US, UK & Europe based on their experience. These might not work effectively for us in India.
With that disclaimer, let’s discuss the most popular and helpful thumb rules.
Top 10 personal finance thumb rules
1. 1-Week spending rule
We often buy things impulsively and regret them later. So, the 1-week rule is a brilliant strategy to prevent impulse spending. It is simple. You give yourself a cooling-off period of 7 days before making purchases.
This would give you enough time to think about whether you really need that product or service, and you won’t regret buying it.
2. 10-5-3 Rule
This rule suggests some reasonable return expectations. In the long term, you can expect 10% returns from equity, 5% from debt/fixed deposits and 3% from the savings account.
These numbers may sound very conservative, but they are very reasonable. It is better to use these returns expectation while planning your long-term investments. And if you receive better returns, it is great, right?
3. 50-30-20 budget rule
This rule suggests how your income allocation should be. It says you to divide your income into –
- 50% – Needs (Groceries, rent, electricity, etc)
- 30% – Wants (Entertainment, vacations, etc)
- 20% – Savings (Equity, MFs, emergency fund, etc)
This gives us a starting point. You can always invest over 20% and reduce your wants based on your lifestyle.
We have already discussed this and other budget rules here.
4. 3X emergency rule
Always put at least 3 times your monthly income in emergency funds for emergencies, such as loss of employment, medical emergency, etc. Either this or 6 to 12 months’ worth of expenses. We discussed this in detail here.
5. 40% EMI rule
You should never have your EMI payments go beyond 40% of your monthly income. Going beyond this will affect your finances severely. Avoid this common mistake.
We discussed a few more common mistakes you should avoid here.
6. Life insurance rule
Always have a life cover of 10 to 20 times your annual income.
You can opt for a life stage increasing coverage or buy a new policy once your income increases significantly. We discussed more on life insurance here.
7. 4% withdrawal rule
After retirement, you won’t be able to earn any active income. You will depend on the corpus you accumulated until your retirement and the passive income generated by the corpus investment.
This rule helps us plan how much corpus you would need before retirement and how much you can withdraw every year for your expenses.
To calculate your corpus, multiply your annual expense by 25. If your annual expense is ₹6 lakhs, you will need a corpus of ₹1.5 cr. The rule suggests you have 50% of your corpus in equity and the other 50% in debt.
And you can withdraw 4% of your corpus (that is ₹6 lakhs of ₹1.5cr) every year after your retirement.
Now research suggests that this rule worked 96% of the time in a 30-year period in the US. But the future is unpredictable. So our suggestion would be to use this rule as a starting point and adjust numbers based on preference.
8. Rule of 72/114/144
When you are planning to invest your money, you would think about how long it will take for your money to double or triple, right? (Akshay Kumar’s paisa hi paisa hoga scene plays in your mind)
How to use it? You divide 72 by the return percentage you expect to receive on your investments.
If you expect to receive 10% returns, thus 72/10 gives you 7.2. Therefore, it will take 7.2 years to double your money with 10% returns.
If your returns increase to 12%, your money will double in 6 years. And if you receive 8% returns, it will take 9 years.
To find out how long it will take to triple and quadruple your money, use the 114 and 144 rules in the same way.
9. Rule of 70
Ever wondered how badly the inflation rate will affect the value of your cash if not invested?
By the rule of 70, you can find out how fast it will halve the value of your money.
If you divide 70 by the current inflation rate, that is 7.4%. Then your money’s value will be reduced by 50% in the next 9.4 years.
So you need to invest your money to beat inflation and increase the value of your money.
10. 80-20 Rule (Pareto principle)
You would have heard about this rule in your school or college, right? But how does this work in finances?
It’s simple. Most people are overwhelmed with fixing their finances. We all think there is so much to do in finance that we cannot keep up and fix it by ourselves. We need help from experts, right? Wrong.
Personal finance is made to look complex, so you get overwhelmed and request an expert’s service. That’s their business.
But in reality, if you fix 20% of the basic things in your personal finance, it will solve over 80% of your problems. Yes, you heard it right.
Think about it. Let’s say you have an emergency fund, health & life insurance, basic budget, invest every month and avoid common mistakes. Doesn’t this solve most of your problems?
Just performing the basics of personal finance will solve over 80% of your financial problem and place you in the top 95% percentile, whose financials are well set.
This rule is the most useful one. Since it is a basic rule and not related directly to finance, people ignore it.
And to help beginners to perform the basics of personal finance, we created a beginner’s checklist. Completing this checklist will have a tremendous impact on your personal finance. So go ahead and check it out. Also, share it with your friends and family.
Share it with your buddies.
Still Curious?
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
ET Money – Top 11 Financial Planning Thumb Rules
Jay Kapoor – 5 Popular Personal Finance Thumb Rules You Should Know
DoughRoller – 31 Best Money Rules of Thumb You Need to Know
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.