Personal finance is a key ingredient in your recipe of everyday life. If you must have read ‘The Psychology of Money’ by Morgan Housel, you’d know how your relationship with money is deeply connected to your psychology. In fact, we underestimate the importance of good financial habits in our lives. There’s a difference between being rich and being wealthy. And the lack of understanding of basic financial rules will eventually have a say in which side we sway to.
In this article, we’ll take you through some widespread personal finance rules for you to follow in order to grow your money. If used correctly, these rules will drastically improve your financial health. It will eventually help you buy that house you’ve been longing for.
1. Personal Finance: Rule of 70
The Rule of 70 is a simple measure to know how quickly the value of your money will reduce to half of its current value. Divide 70 by current inflation rate to know how fast the value of your investment will get reduced to half its present value.
Assuming an inflation rate of 7%, the value of your investment will reduce to half of its present value in 10 years.
2. Rule of 72
The Rule of 72 explores the duration it takes to double your money. It tells you the number of years required to double your money at a given rate. All you have to do is just divide 72 by the interest rate of your investment instrument.
For example, if you want to know how long it will take to double your money at 6% interest rate – which is typically offered by Fixed Deposits – divide 72 by 6. The answer you get is 12. So, it’ll take your money 12 years to appreciate 100% from its present value.
Historically, Index Funds have provided a 15% return on investment every year. If we apply the Rule of 72, your money will double in approximately 5 years if you invest in Index Funds.
3. 100 minus your age Rule
This personal finance rule is used for asset allocation. Equity and Debt are the two assets that you can allocate your assets in. As the rule says, simply subtract your age from 100 to find out how much of your portfolio should be allocated to equities. The remainder should be allocated to debt.
Suppose your age is 25. So, as per the rule, (100 – 25 = 75).
Equity : 75%
Debt : 25%
Thus, you should be allocating 75% of your investment portfolio to equity and the rest to debt.
But if your age is 60, so (100 – 60 = 40)
Equity : 40%
Debt : 60%
This rule gives you a general idea of your risk appetite. The younger you are, the more risk you can afford to take to grow your money. In latter stages of your life, you should be protecting the wealth you’ve accumulated over the years. Hence, majority of your portfolio in old age should be comprising of debt instruments.
4. 10-5-3 Rule
The equity markets have provided great return on investment since the market crash in early 2020. However, 30-40% returns are unrealistic in the long term. Since the Russia-Ukraine war, the equity markets have corrected substantially. One should have reasonable expectations of returns from any instrument that you choose to invest.
The 10-5-3 Rule states that you should be expecting:
10℅ Rate of return from Equity / Mutual Funds;
5℅ from Debts ( Fixed Deposits or Other Debt instruments);
And 3℅ from Savings Account.
5. 50-30-20 Rule
Managing your expenses can be a challenging task to say the least. However, by having a proper allocation of your expenses with respect to your income, you can streamline your monthly cash flow and keep your personal finance healthy.
The 50-30-20 Rule states that you should be allocating 50% of your income to needs, 30% to wants and 20% to savings. Let’s consider an example to understand this better.
Suppose you earn INR 50 thousand a month.
Divide your income into 3 segments as per the 50-30-20 Rule.
50℅ – Needs (Groceries, rent, EMI, etc)
30℅ – Wants (Entertainment, vacations, etc)
20℅ – Savings (Equity, MFs, Debt, FD, etc)
Thus, you’ll be spending INR 25 thousand on your needs, INR 15 thousand on your wants and savings INR 10 thousand.
You must aim to save at least 20℅ of your income. You can definitely save more. And don’t just save, invest!
6. Emergency Fund Rule
You must always have some funds tucked away for emergencies. Emergencies can be anything from maintenance repairs for your house or a sudden breakdown of your car.
An Emergency Fund can take care of your monthly expenses if you just lost a job, or are planning on switching careers and is an important parameter of personal finance. Always put at least 3 times your monthly income in Emergency Funds for emergencies such as loss of employment, medical emergency, etc.
If you’ve already set aside an Emergency Fund of 3X your monthly income, consider increasing it to 6X to be on the safer side. This way, you can rely on your funds without having to tap into your investments just in case you need more money.
7. 40℅ EMI Rule
One must never go beyond 40℅ of your income into EMIs. This includes all your debts. Let’s say you earn INR 50 thousand a month. So you should not have EMIs more than INR 20 thousand.
This Rule is generally used by finance companies as a parameter to check for eligibility to provide loans. You can use it to manage your finances and keep your financial health in check.
8. Life Insurance Rule
Insurance has always been a vital risk management instrument to protect both our lives and the one’s who depend on us. COVID times have made us introspect on the importance of insurance to protect our families in our absence.
The Life Insurance Rule states that you must always have a minimum Sum Assured of 20 times your Annual Income. Let’s say you earn INR 5 Lakh annually. According to the rule, you should atleast have INR 1 Crore in life insurance.
Many banking and other financial institutions have a mandatory ask for a life insurance of the person availing a home loan. This is to protect the interest of both the banks and the dependent family in case of an untimely death of the home buyer.
Plan of Action
Now that you have a fair idea of how you can fix and change your personal finance for better, it is time to put it to good use. Besides equity investments, real estate investments can be a good option if you are looking for a steady cash flow over time. Real estate also acts as a hedge against inflation. If you haven’t yet checked out our article on Real Estate as a hedge against inflation, please click here to check it out.