Interesting Thumb Rules (Part-1)

Ever wondered how much should you invest in equities? In what time will your money double? Most of our money related questions often have complex answers which are boring and beyond comprehension for most of us. Well, now you can take a break from the calculators and take a look at a few quick thumb rules for the same. These thumb rules are interesting, easy calculation tips which we can use in our daily lives. But we also have to be careful as the results are often approximate and may not be ‘exact’ answers we are looking for.

* Rule of 72 – When will my money double?

Rule of 72 simply tells us the number of years in which our money would double. Divide 72 by the rate of interest & you will get the number of years in which the money would double. Ex. if the interest rate is 8%, then it would take 72/8 = 9 years to double.

* Rule of 114 – When will my money Triple?

Rule of 114 is same as above & it gives us the number of years in which the money will triple. Divide 114 by the rate of interest & you will get the number of years in which the money would double. Ex. if the interest rate is 8%, then it would take 114/8 = 14.25 years to triple the money.

  • Using the above two rules, one can find out the effect of Inflation (or) the Rate of Interest by simply dividing 72 or 114 by the number of years.

* 100 Minus Your Age Rule – To figure how much should I invest in Equities

One of the basic ideas while investing in equities is to reduce the exposure as you grow older. But, apart from age, there are also many other factors affecting your asset allocation which makes risk profiling an important exercise. For the rest of us, this rule easily gives an idea on the extent of equity exposure, considering the age. For ex., if your age is 40, your equity exposure should be at (100-40 = 60) 60%. The balance would be invested in debt and other safer asset classes. Note that this old rule is contested by many experts today who argue that 100 be replaced by 110 or 120 or even higher considering the need for wealth creation, longer life expectancy and low debt returns.

* 20/4/10 Rule – For buying a Vehicle

The rule says that while getting a loan for a vehicle, you should first put down at least 20% as the down-payment, the loan term should not be for more than 4 years and that your total monthly transportation costs (including EMIs) should not be over 10% of your income. This rule can thus also help you know whether you can truly afford to buy the vehicle of your choice.

* 80% Income Replacement Rule – To determine how much should one earn after retirement

Many experts believe that we should aim for replacement of 80% of our income after retirement to live comfortably. This presumably takes care of the reduced expenses on one hand while maintaining the living standards on the other hand.

* 4% Withdrawal Rule – Safe withdrawal amount from Retirement kitty every year 

This rule is used very often in retirement planning where the idea is to arrive at a withdrawal figure every year that will keep the retirement kitty intact while you are not generating any other income. The rule says that we can withdraw 4% annually from the outstanding balance amount to keep the capital safe. While there are many faults and misses in this assumption, like the rate of return, inflation, life expectancy, etc., the underlying idea is not entirely lost. Some experts say that the actual figure should be less than 4%, preferably 3%. The lesser the figure the better it is as it can ensure you do not run out of your retirement kitty any time soon.

* Pay Yourself First Rule – For Financial Freedom & Independence

This is a simple yet very important rule used in financial planning, especially retirement planning. The rule requires us to save for our own future (read retirement) first before anything else. The idea is to make an automatic arrangement from your bank account every month so that, the money is auto-deducted first every month after your receive your cash inflow, like salary. The process of automatic routing is said to be like ‘paying yourself first’ since money is deducted before other expenses are incurred.

To Be Continued…

Source: NJ Publications

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