Financial Chronicle, 8/9/2011
In life people want shortcuts – I think that’s the reason thumb rules find some place in one’s life. Financial planning is a complete process to achieve your goals, but sometimes you want quick answers. And here comes role of thumb rules – they just give you some idea about financial decisions.
Saving and investing rules of thumb
What should be my asset allocation?
This is the most common rule of thumb that is used in the investment world. Rule says equity percentage in your portfolio should be equal to 100 minus your age or in other words debt should be equal to your age. For example, if you are 30 you should have 30 per cent of your investments in debt and 70 per cent in equity.
How much emergency fund?
An emergency fund helps people in case of sudden loss of income and medical emergency. Thumb rule says one should have an emergency fund equal to three to six months of monthly expenses. You can keep it at three months if you are a government servant but in case of private job or profession, you should keep it on the higher side of the range.
Retirement rules of thumb
How much corpus for retirement?
You should have 20 times your income saved for retirement and plan to replace 80 per cent of pre-retirement income. But, here, retirement means a retirement at age of 60 and life expectancy of 80 – and a conservative lifestyle.
How much to invest monthly?
“Indians are great savers” sorry “Indians were great savers”. The new generation is somewhat different and they would like to enjoy the present and have no idea about future. If you have just started to work and would like to have a very simple lifestyle and retirement at age of 60, you can do it with saving (read investing) 10 per cent of your income. If you are planning for an early retirement, start with 20 per cent savings.
Insurance rules of thumb
How much insurance should I have?
Here insurance means insurance. Rule says one should have sum assured of eight to ten times of his yearly income. I think this rule is far from perfect but still can be used as starting point. This does not take care of any of your goals, liabilities and even complete expenses. Some modified version of this rule says that if you are in early 30s insurance should be 12-15 times of your annual income and if you are in 50s take six to eight times.
Loan/liability/home rules of thumb
How big should be my house?
The value of house should be equal to two to three times of your family annual income. So if you and your spouse are earning total Rs 20 lakh, you should buy a house in range of Rs 40-60 lakh. Buying house is one of the most important financial decision and one should look at more factors.
Maximum EMI that I can have?
Ideally zero will be the best answer but few of the big assets like home requires some loan to buy them. Experts agree that your EMIs should not be more than 36 per cent of gross monthly income at any point of time. It should be even lesser when you are close to your retirement. If you want to talk about home loan EMI, it should not be greater than 28 per cent of your gross income. Now tenure of loan is missing here – for tenure read number six and eight rules of thumb.
Rate of return rules of thumb
In how many years my amount will double?
It’s a very simple and most common rule – if you divide 72 by rate of return you will get the number of years in which your money will double. For example, if you expect a rate of return of 12 per cent you money will double in six years (72/12=6) and what about if rate of return is 8 per cent – 72/8=9 years. This can also be used in reverse order at what rate your money will double in five years – 72/5=14.4 per cent.
This is a US rule of thumb which says in long term you can get 10 per cent return from equity, 5 per cent return from bonds (let’s say FDs) and 3 per cent from the T-bills (liquid funds – these returns are more or less close to the range of inflation). For Indians, rule can safely be be 12/8/6. Indian economy is growing at some different pace and even inflation numbers are different. Can we safely say if inflation is 6 per cent (T-bill rates) we can get 8 per cent from the fixed deposits and 12 per cent from the equity or in other words – in long term equities will deliver twice the return of inflation
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