Thumb rules are just a piece of advice. It is to be learnt, remembered and amplified. When it comes to personal finance thumb rules, there are a few popular ones. These rules are not sacrosanct, but serve as broad guidelines. Let’s take a look at a few thumb rules and see how they can bring you financial freedom.
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See Also: Borrowing Rules for Financial Well-Being
You must save at least 30% of your income. Well, if you can’t, then follow this thumb rule, save at least 10% of your income. If you are at the start of your career, save at least 10% of post-tax income. As income rises, make sure savings goes up to 15% of post-tax income. This money could be handy in an emergency. Save at least 30% of post-tax income when you enter middle age. This is when expenses go up.
The 50-20-30 Rule teaches you how to save and spend. Make sure 50% of income goes towards living expenses. Living expenses are basically household expenses, groceries and so on. Make sure 20% of earnings go towards saving for short, medium and long-term goals. The remaining 30% goes towards spending on food and travel. You can tweak percentage based on age and circumstances.
You must have at least 3-6 months of living expenses in your emergency fund. Have at least 6 months of living expenses if you are unmarried. Make this 3 months if you are unmarried. Self-employed must have at least 12 months of living expenses in the emergency fund. These are not hard and fast rules, but can be tailored according to needs.
This rules helps maintain finances when buying a car. Twenty is the down payment amount. You must pay 20% of the car cost as a down-payment. Try to make as much down payment as possible. The higher the down payment lower the car loan EMIs. Banks offer car loans with repayment tenure of 7 years. It’s best to stick to repayment tenure of 4 years to reduce repayment stress. Make sure at least 10% of take home salary goes towards car loan EMIs.
Get life insurance especially term life insurance to protect loved ones on an untimely demise. Term life insurance is pure protection life insurance, where on demise of the policyholder, the family members get the sum assured also called death benefit. There are no survival benefits. Make sure term life cover is at least 15-20 times annual income. Take health insurance to cover emergency hospitalization.
Make sure Home Loan EMIs don’t exceed 30% of monthly income. Total loan EMIs mustn’t exceed 50% of monthly income. The Income-to-EMI ratio must be around 50%. Before applying for a home loan with bank or NBFC, make sure that credit score is 750 or above.
Follow the ‘100 minus age’ approach when investing in equity. What does this mean? If you are 35 years old, invest at least 100-35 = 65% of investible surplus in equities. The rest must be in debt. This is an investment in PPF, NSC, Post Office Schemes and so on.
Do understand that equities are risky and allocation reduces as you age. When you reach 45 years of age, reduce equity allocation to 55%. You must realize that allocation to equities depends on financial goals. Invest in equity with a long-term horizon which exceeds 5 years. Equities are excellent for retirement planning.
The Rule of 72 is a great way to determine how fast an investment doubles at a fixed annual rate of interest. You must divide 72 by annual rate of interest to get a rough estimate on how fast money doubles.
Let’s have an example:
You invest in an equity mutual fund which gives an average return of 12% a year. Your money doubles in 72/12 = 6 years.
You invest in FD which offers 8% interest. Your money doubles in 72/8 = 9 years.
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