Having a thumb to follow in your investment and savings journey can come in handy as they can be used as a guiding light. These thumb rules can be used by those who are just beginning their financial planning, as well as by those in the middle of their career and don't yet have a proper plan in place. However, do keep in mind that there's no 'one size fits all', as these rules only provide a general direction and may not necessarily give you the exact picture.
With that being said, here are 10 financial planning thumb rules you can use in your financial planning journey.
Pay yourself first
This means that a certain percentage of your monthly income must be saved before you spend it. 'Income minus savings equal to expenses' should be the rule. For this, identify your goals, estimate the inflation-adjusted money requirement, and then find out how much you need to save for these goals. After this, make sure that each month funds move out from your salary towards your goals, and manage your household expenses with what is left.
How much should you save
For someone starting their career at the age of say 25 years, 10 per cent of the post-tax income can be saved. Over time, as your income increases, up this number to 15 per cent. As you grow older and your income rises and financial liabilities too add up, make sure you are saving enough towards your goals. By the time you are in your 40s, save at least 35 per cent of your post-tax income.
50-20-30 rule
This rule will help you with how much to save and how much to spend in a month. Here, 50 per cent of your income should go towards living expenses, like household expenses, groceries; 20 per cent towards savings for your short, medium, long-term goals; and 30 per cent towards spending, including outings, food and travel. You can tweak the percentages according to your age, circ*mstances, etc.
20/4/10 Rule
This rule helps keep your finances under control when you're buying a new car. Here, 20 stands for the down payment amount, i.e., 20 per cent of the car price should be paid by you. However, it is better to make as much down payment as possible. Four stands for the number of years of financing. Although lenders have a tenure of up to 7 years, it's better to stick to 4 years. 10 stands for the ideal percentage of your net-take home salary that should go towards the car loan EMIs.
Have an emergency fund
An emergency can happen anytime and needs immediate action. Your emergency fund is not meant to meet your planned goals, but it only acts as a safety net. Although there's no fixed rule on how much emergency cash one would need, ideally 3-6 months' household expenses should be one's emergency corpus.
How much life insurance you need
Ideally, you should have a life insurance cover which is at least 10 times your annual income. The actual requirement may, however, depend on your age, money goals, financial dependents, accumulated wealth, etc. The most cost-effective way of buying life insurance is through a pure term insurance plan. A pure term plan is a low premium, high-cover protection plan where the premium goes entirely towards risk coverage. On surviving the life insurance policy's term, you won't get anything back as there is no savings portion of the premium.
How much to save for retirement
Most financial planners suggest a retirement corpus target that is about 20 times your annual income. While some feel that 30 times can be a better figure as it will take care of inflation. It gives you a reason to work backward and estimate how much you need to save from today till the time you retire. However, before using this rule, do note two points. First, this rule only considers income and not expenses. Second, it may work better for those whose retirement is years away than those who are retiring soon.
How much home loan to take
Banks and other lenders do not lend an amount on which the EMIs will be more than 45-50 per cent of the monthly take-home pay of the borrower, and this includes any other existing EMIs on car or personal loans. Monthly EMI on the home loan should be less than 30 per cent of the monthly income. Total EMI obligations (home and other loans) should ideally be less than 50 per cent of monthly income. Also, ensure that your credit score is 750 plus so you can get the best terms.
How much to invest in equity
It's often said that one must use the '100 minus age' approach when it comes to equity investments. For a 30-year-old, 70 per cent of his investible surplus should be in equities and the rest should be put in debt. And as one ages, the allocation towards equities should be reduced. For long-term goals such as retirement, being aggressive in equities will help, till at least three years before retiring.
How to diversify
You don't need more than four to six schemes to diversify your portfolio. If you are investing a small amount, you don't need to invest in more than one or two schemes. Investing in every mutual fund category will not offer you the best return or diversification. Have a focused portfolio in line with your goal, horizon, and risk profile - this is extremely important if you are investing a small amount.
