With thousands of investment choices, the infinite variations can be incredibly complicated.
So when you have a large number of options available in front of you and an overwhelming stake in making the right decision, the entire process can get unbelievably complex.
This is why you need some thumb rules to simplify the process. They are an effortless way of cutting through the complexities to help you make intelligent decisions quickly without getting hassled by endless questions regarding how or what's next.
Let's look at some popular thumb rules of investing and how they can apply to you.
1. Rule Of 72
This thumb rule talks about the number of years you can double your money at a given rate.
It's a simple formula. All you need to do is divide 72 by the interest rate.
Rule of 72: N = 72/R
- N = number of years
- 72 = the constant variable
- R = interest rate
For instance, let's say you are eager to know how long it would take to double your money at an interest rate of 8%. So what you do is divide 72 by 8, and you get 9 years. Similarly, if you use a 6% interest rate, it could take you 12 years, whereas choosing a 9% interest rate could take you eight years.
2. Rule Of 114
This rule takes the rule of 72 to the next level. That means you can use the rule of 114 to determine how long will it take for your investment to triple.
Rule of 114: N = 114/R
- N = number of years
- 114 = the constant variable
- R = interest rate
For example, your investment at an assumed 10% interest rate will triple in about 11 years [114/10].
3. 100 Minus Age Rule
This rule stipulates that the percentage of your portfolio you should keep in stocks must be the number you get when you need to subtract your age from 100.
For instance, let's assume you are 30 years. Based on the 100 minus age rule, you need to keep 70% of your portfolio in stocks and the remainder in debt instruments. Similarly, if you're aged 70, you would need to keep 30% of your portfolio in stocks and the rest in debt.
The only issue with this rule is that with people living longer lives, financial planners are now recommending that the rule be tweaked to 110 minus age rule or 120 minus age. This is because if you're looking to make your money last longer, you need the extra growth that equities or stocks can provide.
4. 4% Withdrawal Rule
This is a rule that can tell you how much you can safely withdraw once you've retired. It is a simple rule of thumb when it comes to retirement income.
According to the 4% withdrawal rule, you can safely withdraw the amount equal to 4% of your savings in the year you retire and then adjust for inflation every subsequent year for 30 years. This rule can help you avoid running out of money in your retirement years to ensure you have a predictable and steady income.
For example, let's say you've retired at the age of 60 with an investment corpus of ₹5 crores. If you withdraw 4% of your portfolio, that is ₹20 lakhs every year, you can ensure that your money will last you until you turn 90.
5. 10,5,3 Rule
This rule applies to asset allocation and is used for long-term investments. By long-term, we mean a period of at least 15 to 20 years.
The 10,5,3 rule comes from a book by James O'Donnell, who wrote - The Shortest Investment Book Ever: Wall Street Secrets for Making Every Dollar Count.
It's a simple rule. It gives you an overall average annual return for three types of investment classes: equities, bonds and cash. Based on this rule, equities are likely to provide you with a yearly return of 10%, bonds 5% and cash 3%. This rule can help you determine your asset allocation for the long run and is particularly useful when applying to your retirement portfolio. This rule can be combined with the rule of 72 to show how long it can take for every asset class to approximately double in value.
6. The Emergency Fund Rule
How can you find how much you need to save the right emergency fund amount? Ideally, it would help if you had at least 6 to 9 months' worth of living expenses covering housing, food, healthcare, including insurance, utilities, personal expenses and transportation.
Until a while back, experts opined 3 to 6 months' worth of expenses to be the ideal benchmark. However, ever since the pandemic, extending the time frame can ensure that you have enough to cover yourself in the event of an unexpected expense. If you're worried that you cannot save enough, you can start small and build it up over time.
For instance, let's say you set aside ₹25 a week in an emergency fund. Now the end of two years, you could have ₹2600 will be saved. What if you increase the amount to ₹50 a week. That means your savings could grow to ₹5200. Now, if you make it ₹75 a week, you will see an even larger amount saved — ₹7800.
While this is an example with a low amount, the size of your emergency fund will depend upon your lifestyle, obligations, income and dependence. Also, consider adjusting the emergency fund amount based on your family needs, job stability, monthly costs and other factors.
7. 10% For Retirement Rule
This is not exactly a rule; it is more of a guideline or a personal commitment. It informs you how much of your gross income you need to set aside for your retirement. The 10% For Retirement Rule is based on a simple equation: divide your gross earnings by 10.
For example, if you earn ₹10,000 a month, it means you would need to set aside ₹1000 towards savings. When you establish a personal budget that keeps aside 10% of your overall income, it shows that you are taking a proactive method to prioritise your savings.
This story is a part of BOOM Money's series on personal finance