Thumb rules mean a simplified piece of advice regarding something. It is not strictly accurate for every situation. However it is something that is easily learnt, remembered and applied. There are several thumb rules for your personal finances too. Like any thumb rule they are not sacrosanct and neither are they applicable for everyone, but they do provide broad guidelines that one needs to keep in mind.
Here, we shall discuss 5 popular personal finance thumb rules;
This is one of the most basic of thumb rules. The iconic book on financial advice, The Richest Man in Babylon by George S. Clayson also mentions this. The key to build wealth for your future is to save 10 per cent of your income. You can read that as at least 10 per cent of your income. But the idea is to plan how much you need for your retirement and then to save accordingly. If you do those calculations, 10 per cent might not be enough. However, as we will see with any rule of thumb, you get the drift.
You would know the importance of creating an emergency fund. The idea is to keep 3-6 months of your total monthly expenses in the emergency fund. This should regular expenses, EMIs and insurance premiums. The 3 months time period is for those who have a secure job like a government job. For those in a private job, an emergency fund, worth at least 6 months’ expenses is recommended. Whereas for those who are self employed, an emergency fund worth 12 months’ expenses should be kept aside. Again, there are no hard and fast rules, but you get the general idea.
When investing, it is advisable to divide one’s investments into debt and equity. This thumb rule suggests that the per centage of equity in your portfolio should be 100 minus your age. So when you are 30, the equity portion of your portfolio should be 70 per cent. When you are 40, it should be 60 per cent and when you are 50, it should be 50 per cent. This thumb rule is based on the fact that equity investments deliver good returns over a longer time period as market volatilities even out. So when you have a long term investment horizon you should invest more in equities and decrease it as you near your goal. However this rule is flexible and depends on one’s risk appetite. At 30, one may have 90 or even 100 per cent of one’s investments in equity. One may move up to 90 per cent to debt by the time one is a couple of years away from retirement.
The thumb rule states that EMIs as a percentage of your income should not exceed 35-40 per cent. Anything above that might strain your finances. So, if your monthly income is Rs 1 lakh, your total EMI outgo for loans should not be more than 40 per cent. It is better if it is lesser, but you should not cross this limit. This one is a thumb rule that pretty much applies to everyone.
How much do you need every month after you retire? The thumb rule says 80 per cent of your current total expenses. This assumes that certain expenses reduce after retirement. This may include the daily transport expenses. Or the children may move out. However there are two things to take note of in this case. Nowadays people prefer to travel and pursue hobbies after they retire. So, one may need more income than the thumb rule prescribes.
Also, this is for calculating the present value of money required. One needs to factor in the inflation. Let us suppose you are 25 years from retirement. You have figured out that you require Rs 60,000 every month in retirement. The money you would require about Rs 3.25 lakh in the first month after you retire at an inflation of 7 per cent.
There are several other personal finance thumb rules that you would come across. Remember, they are not set in stone, but they serve their purpose.