Investors are usually in a catch-22 situation when managing personal finance because they need to spend and save at the same time. The way to overcome this problem is by following financial discipline with a simple budgeting thumb rule-the 70-20-10 rule. Here’s how it works.
70% – Essentials And Discretionary Spends
A significant portion of the income is spent on essentials and discretionary expenses. The inevitable expenses of your daily life are categorised as essential spending. These include utility bills, groceries, medical costs, insurance, rent, etc. Discretionary spending is voluntary, like buying clothes, going out for dinner, or planning a holiday. The rule suggests that 70 per cent of your income should be budgeted for these expenses. Always keep track and periodically review all these spends.
20% – Savings
Save as you earn! This is the stepping stone into the world of personal finance management. The rule states that at least 20 per cent of your income should be saved and divided into a contingency fund and investments.
A contingency fund is a reserve fund that needs to be kept aside for unforeseen circumstances such as medical emergencies or job loss. While setting up this fund, it is crucial to consider the number of dependent family members and their age. First, set up a contingency fund and start investing to meet your financial goals.
Investments have a compounding effect. The sooner you start investing, the better it is for your assets to grow. One of the best ways to build a savings habit is investing through Systematic Investment Plans (SIPs). Just like paying your EMIs every month, you can save by investing through SIPs every month.
10% – Debt
The rule suggests that no more than 10 per cent of your income should ideally be spent on repaying loans or credit card bills. Debt repayment should be well planned by considering your various income sources. Pre-pay your loans rather than waiting for the completion of the loan tenure. This helps you save the interest cost that can be utilised to reinvest.
Pay your EMIs on time to avoid penalties and maintain a good credit score. The credit score is an essential indicator of your ability to repay loans. Financial institutions consider your credit score for risk assessment when you apply for a loan. If you have a good credit history, you are more likely to qualify for a loan with lower interest rates.
The budgeting thumb rule may not be the same for all. You can choose your own rule based on your financial backdrop, like 70-10-20 or 80-10-10.
Asset Allocation, Portfolio Rebalancing
Asset allocation plays a significant role while building your investment portfolio. Having an optimal asset allocation helps balance your risk and returns. You can invest in various asset classes like equity, debt, cash and equivalents, commodities, real estate, etc., that help mitigate market volatility and concentration risks. A well-diversified investment portfolio can be built based on your short- and long-term financial goals like purchasing a new car or home, marriage, international holiday, children's education, retirement, etc. It is important to periodically rebalance your investment portfolio to maintain the target asset allocation and achieve short-term financial goals. For example, while rebalancing your equity portfolio, you can book profits in outperforming stocks and invest in underperforming stocks.
Taxation is an important aspect that needs to be considered while managing your personal finance. All financial products have different tax implications and benefits. Investing in tax-saving instruments can be a win-win situation, as it helps save taxes and create wealth. With thorough research and advice from your financial advisor, you can seamlessly navigate the tax planning process.
The fear of missing out (FOMO) effect is often observed among investors as they make investment decisions. Controlling your emotions and investing wisely is key to investing successfully. Just like online shopping, investments can be made through one-stop-shop fintech platforms. Don't let all the investment opportunities overwhelm you and lead to impulsive decisions. An experienced financial advisor can guide you as you step into the world of personal finance management.
The author is co-founder, Wint Wealth