Personal finance is a term that covers managing your money as well as saving and investing.
It encompasses budgeting, banking, insurance, mortgages, investments, retirement planning, and tax and estate planning.
On the other hand, Rules are nothing but small sets of boundaries which are pre-set and the same are not to be crossed to ensure the smooth execution of a particular process or activity. Be it sports, games, schools, colleges, factories and offices, even cities, states and our country, for smooth governance and management everything is to be abided by the RULE.
So, why one should follow the rules? Basically, following rules provide us with discipline and it ensures the smooth working of any particular activity. It tells us what needs to be done and what shouldn’t be done. It also tends us to be very serious towards our goals and ensures growth. On the other hand, if we don’t follow rules there will be complete Chaos all around. Our city and state administration will be completely choked up, and there will be problems in running the country even schools, colleges, offices, and factories if basic rules are not followed.
Imagine playing a game of cricket with no rules. It is almost impossible. In our childhood days or even on weekends today when we play a game of cricket in our society, before starting the game of cricket, there is a team which is formed and then the rules are defined like how much over the game we will be playing, who will bat first or who will bowl first, how the fours and sixes will be decided, whether it will be over the arm or under the arms game ( mostly it is under the arms game because of lack of space) so on and so forth. So these basic rules define the smooth running of the game and help us choose winners or losers without any chaos.
The same applies to Personal Finance. As Investors, we tend to forget or even learn the rule of personal finance or investments. Actually, there was no course or subject in our schooling days or in our colleges to ensure what needs to be done with the money once we start earning. Our education system has basically failed from providing us with the learnings on this topic of personal finance.
So, here we try and understand a few basic rules of personal finance that we all should know while managing our own finances. I have broken down the same into nine basic rules of personal finance. So, let's start with the first rule.
The first rule is the Rule of 72. This rule primarily tells us how much time will it take for my money to get doubled. As an investor we are more keen towards doubling our money without considering the rate of interest or return on investment it has to offer. So, this rule helps us to understand the same. Let us understand this with the help of an example. If I invest today ₹ 100,000/- at a rate of 8 % p.a. how much time it should take for my money to get doubled? Here the rule of 72 comes into the picture, the rule of 72 says, to divide the number 72 by the rate of interest, and the number you get is the number of years it will take for the money to double. In this case, we will be dividing 72 by 8 i.e. 9. So it will take 9 years for money to double if it is offering me an 8% p.a. rate of interest.
The Second Rule is the Rule of 70. This rule is the inflation rule. This rule tells us how much time it will take for the value of your money to turn into half over a period of time. For example, if we take ₹ 100,000/- and consider the current inflation rate is 7% we have to divide the number 70 with the inflation rate i.e. 7 the number comes to 10. So it will take 10 years for the value of ₹ 100,000/- to turn half.
So if I am able to buy 15 grams of gold today with ₹ 100,000/- I will be able to buy 7.5 grams of gold with the same ₹ 100,000/- down the line 10 years with inflation of 7%. turning the value of ₹ 100,000/- to half.
The third rule is the 4% withdrawal rule. This rule talks about how much money one should be withdrawing from their retirement portfolio. If today you have created a portfolio of let’s say 3 crores and you plan to retire what should be the amount of withdrawal you should be doing from the portfolio? As you are retiring you will have to rely on the withdrawal amount from your corpus as your monthly income, all the other incomes you had, have basically stopped. So the withdrawal rate you must adhere to is 4% and not more. The reason is pretty simple, if you withdraw more than 4% the retirement portfolio you have, will not last long and the time will come you must have exhausted the corpus. The maths behind this is very simple.
Annual Expenses X 25 = Investments required for Early retirement / at retirement
If you can live off ₹ 12 lakhs per year in retirement then,
12 lakhs X 25 = 3 crore
4% of 3 crore = 12 lakhs ( your annual expenses)
The 4 % rule is the basic theory that you can withdraw 4% of your money from retirement corpus each year you will never run out of your money.
As long as your retirement portfolio is growing by 4% p.a inflation adjusted your portfolio will in fact continue to grow.
The fourth rule is the 100 minus age rule. The rule is the asset or investment allocation rule and talks about how much allocation one should have towards equity and debt basis the current age of the Investor. If your age as of today is 30 your allocation towards Debt / Fixed income should be 30% and that of Equity should be 70%. If your age is 40 years, your allocation towards Debt/Fixed income will be 40% and Equity should be 60% If your age is 50 years, it will be 50% Debt and 50% Equity. So as your age increases your allocation towards Debt / Fixed income increases and towards Equity it decreases. This is how you should plan your asset allocation depending on your age as the risk-taking capacity of an individual is high when he is young at age and less when his age increases. So it is always better to keep the allocation according to your age.
The Fifth rule is the rule of 10,5,3 rule also known as the returns expectations rule. This a very simple rule and talks about the return expectations one should have with regard to an asset class.
Equity or Equity mutual fund is 10%, Debt is 5% and Savings account or Liquid fund is 3%. Though there are no guarantees these are the more conservative returns expectations one should have. This basically makes our goal planning and any financial plan more conservative and tends us to invest or save more. Higher expectations lead to disappointment.
The Sixth Rule is the 50-30-20 rule of the Budget Rule. The 50/30/20 rule is an easy budgeting method that can help you to manage your money effectively, simply and sustainably. The basic rule of thumb is to divide your monthly after-tax income into three spending categories:
50% for needs,
30% for wants and
20% for savings or paying off debt.
The Seventh Rule is The 3X Emergency Rule. The term Emergency Fund refers to money kept away to use in times of financial distress. An emergency fund aims to improve financial security by creating a safety net that can meet uncalled expenses, such as an illness or major home repairs. It is advisable to own an emergency fund that's at least three times your current monthly income which is the bare minimum.
You can move up to six months and keep building if you need to do so, but this fund will keep you financially stable in emergencies such as loss of employment, urgent travel, repairs, etc.
The Eighth rule is the 40%, EMI Rule. All of your EMIs combined should be no more than 40 per cent of your In-hand income. For instance, if your In-hand pay is Rs 50,000, then the combined EMIs should ideally be Rs 20,000. If you are thinking of going overboard with this limit, you might strain your finances, lower your savings, and run into the risk of defaulting on your EMIs. Life throws unexpected situations which we can neither avoid nor control. It's advisable to be prepared for such cases and follow the rule to manage and control the way your EMI works.
The Ninth and last rule are Life Insurance Rule. According to the 'Income Rule' used by insurance advisors, one should have a sum assured of 8 to 10 times one's annual income. This thumb rule gives a good starting point for a breadwinner to know the amount one should be insured for in case of any unfortunate event. However, it is a prudent practice to consult a financial planner to calculate the amount of insurance required based on the “Human Life Value” principle, which takes into account the financial goals and the outstanding liabilities while calculating the amount of insurance required.
To conclude, one must be aware of all the nine personal finance rules while managing your finances. You can do some changes here or there at your own convenience. In Personal Finance, the term “ personal “ is pertaining to you in particular, so you can make some tweaks and changes as per your personal needs and situations you are in. The monthly cash flows, the salary, the debt, the earnings, the spending, and the lifestyle you maintain, if any medical patient at home will all be different for different households and it can never be the same. So knowing the rules is one thing and applying them in different situations is as per your need and convenience. Hope these rules help you manage your finances better. Till then, Happy Investing
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