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A rule of thumb is an easy-to-learn basic rule-set applicable for doing a specific task. It includes practical instructions that result from practice and experience, instead of scientific research or a proved theory.
Use of Thumb Rules in Financial Planning
In financial planning, the thumb rules help individuals fulfil their desired goals and achieve financial freedom as well. The thumb rules in financial planning are helpful for those who has just started their career and beginners in path of financial journey.
Related: Beginner’s Guide to Financial Planning
With help of thumb rules, youngsters get some basic guidelines on how to make a beginning, as far as managing personal finances is concerned. It is also useful to those who don’t have enough financial expertise to create a customized financial plan.
Important Thumb Rules in Financial Planning
Follow these thumb rules to manage your personal finances better and it also helps you achieve short & long-term goals.
Also Read: Golden Rules of Financial Planning
Rule #1: Save Before Spending
The first rule in managing personal finance is to ‘pay yourself’. It means that you need to save a certain percentage of money from your monthly income, before start spending. It is the golden rule to attain specific savings every month.
Income – Savings = Expenses
As per Warren Buffet, make savings before spending and don’t save after spending
To achieve savings each month, identify the goals and then make an estimate how much you need to save to achieve those goals. Now, you need to make sure to put aside the funds every month from your monthly income and then manage your expenses with the remaining amount.
‘Pay for yourself’, i.e., save every month to fulfil the future goals.
Rule #2: 50-20-30 Budgeting Rule
50-20-30 budgeting rule is helpful for you to meet your financial needs, attain savings, and fulfil financial goals. According to this rule, 50% of post-tax income (income after paying taxes) should be utilized to meet your essential monthly expenses, 20% of money from monthly income should go towards investments for short & long-term expenses, and the remaining 30% may be used to meet other expenses including food, travel, shopping and outing.
Rule #3: 20-4-10 Rule
This 20-4-10 rule helps manage your finances, when buying a new car. In this rule, 20 stands for 20% of the car price you should pay as down payment. However, it’s wise to pay as down payment as much as possible, as it simply lowers your EMI amount. 4 is the number of years for which you can finance your car purchase. 10 in this rule is, 10% of your monthly salary should contribute towards car loan EMI’s.
Rule #4: Rule of 72
This ‘Rule of 72’ helps calculate the number of years in which you can double your investments. Divide 72 by the rate of return. For example, if you are able to generate 12% rate of return, you will be able to double your investments in 6 years (72/12 = 6).
If you want to know the time required to triple your investment amount, rule of 114 is used. Triple your money in 9.5 years (114/12 = 9.5 years).
Rule of 72: To double investments = 72/expected rate of return
Rule of 114 To triple investments = 114/expected rate of return
Rule of 144: To quadruple investments = 144/expected rate of return
Rule #5: Emergency Fund
An emergency can occur anytime and to anyone. Whether it’s unemployment for a few months or a sudden accident that lead to permanent disability which may impair your earning ability, so everyone need to be ready to face the tough times.
In any point of time, certain expenses are unavoidable and you need to make ways to fulfil those expenses.
You are thus advised to create an emergency fund. Although, there is no specific rule on how much fund one would need, you must maintain an amount that can meet at least 6 months of your expenses. It helps you to meet expenses during financial emergencies.
Rule #6: Life Cover
Life insurance cover ensures financial security for your family. You should get a life cover of at least 10 times to your annual income. The actual requirement may differ depending on one’s age, financial dependents, accumulated savings, financial goals to achieve, and more.
When it comes to buying a life insurance cover, it’s wiser to get a term life insurance plan. It provides pure life cover and you can get the high sum assured at low premium.
Conclusion
No one size fits all and it also applies to financial planning. You need to plan your finances to suit your risk profile, financial goals, savings to invest, etc. Once you start with financial planning, it’s helpful to follow these thumb rules that further facilitate you to reach the goals.