5 Rules Of Thumb For Your Money

It is said that time is money.
So for those of you who are too busy to take an in-depth look into your finances, here is an article that aims at saving you some time – and hopefully some money too! Here are 5 financial rules of thumb that will give you an overview of how to broadly structure your financial life.

 

Please note: Everybody's financial situation is unique – a rule of thumb is only a broad indicator and does not replace a personalized solution. A rule of thumb may or may not be correct for your specific financial situation.

 

• How long will it take to double my money?
  
  Have you ever had an investment salesperson insist that you must buy a certain product because it would double your money in 10 years? The next time this happens to you – do a small calculation to show the salesperson that you know more than he thinks!
  
  The Rule of 72 helps you to calculate what rate of return it requires to double your money in a certain number of years. Alternatively, it can be used to show what number of years it will require to double your money at a particular given rate of return.
  
  Here is how it works:
   

  Rate of Return required to double your money = 72 / Number of years

  
  
  In the above salesperson example, a product that doubles your money in 10 years is giving you an annual rate of return of 7.20% i.e. 72 / 10.
  
  With a 10 year investment horizon you might be better off investing the money into equity yourself and earning a higher rate of return over the 10 year period.
  
  Similarly,
   

  Number of years required to double your money = 72 / Rate of Return

  
  
  If you are earning say 15% on an investment, you can expect your invested money to double in 72/15 years i.e. 4 years and 10 months.
  
  Remember however that the Rule of 72 is only a very broad approximation of the actual answer. To get a more accurate answer, use the number 69 instead of 72. The number 72 is used only because it is easily divisible by many numbers.
  
   
• How much equity exposure should I have?
  
  The broad rule is that your equity exposure should be equal to 100 minus your age. So if you are 35 years old, the equity component of your overall portfolio should be (100 – 35)% = 65%.
  
  However, this rule is again very broad and differs from situation to situation.
  For example, if you have high liabilities and expensive financial goals that are coming up within the next 3 years, then the corpus for these expenses and goals should not be in equity, it should be in debt i.e. fixed income – or else with any major market volatility, the goals will be jeopardized.
  
   
• How much of my monthly take home salary should I save?
  
  Indians are natural savers. But for those of us who want to know how much is the right amount, ideally you should save about 10% of your income every month.
  
  Saving money is essential to your financial well being in the long term.
  In case you face any unexpected expenses in one particular month and are unable to save that 10% of your income, try and make up for it in the next month by saving more and catching up. Remember, a rupee saved is a rupee earned!
  
  The money you save each month can be swept into a 'sweep-in savings account' rather than a regular savings account to give you a little more bang for the buck. A 'sweep in' account is a good way to treat your monthly savings, as it combines the higher rates of a fixed deposit with the liquidity of a saving account. Speak to your bank for specific details that will apply to you.
  
   
• How much home loan can I afford?
  
  Typically, when applying for a home loan, a lender will limit your loan to an EMI that can be serviced by not more than approximately one third of your monthly income.
  
  So if you are earning 30,000 a month, the bank will give you a loan amount wherein your EMIs are not more than 10,000 roughly. This is a good thumb rule to follow as it ensures you do not put too much pressure on yourself to siphon away more than one third of your monthly income towards servicing your debt. This is simply known as your debt-to-income ratio.
  
  If you currently have loans and want to see how much your debt-to-income ratio is, simply total up your monthly fixed income (eg. From salary / business income, rent income if any and other sources of fixed income that will definitely come in every month), total your monthly debt outgoings on any loans you may have (home loan, car loan, personal loan, credit card loan) and divide the debt total by the income total.
  
  If it is more than approximately one third (or 36% to be precise), try to cut it down over time by prepaying the high interest loans first.
  
   
• How much emergency cash should I have?
  
  Everybody agrees that it is essential to hold a contingency fund – money that you will use only in case of an emergency such as a job loss, or loss of income for any other reason. These funds are not to be used for life events such as buying a car, renovating your home, or other such events. But while everybody agrees it is important to hold some money aside, there are different approximations for how much money should be held aside.
  
  Some financial planners say you should hold 3 to 6 months of your monthly expenses in an emergency / contingency fund.
  
  At PersonalFN, we believe you should hold at least 6 months of monthly living expenses in a contingency fund – that includes everything from monthly household expenses, to any EMI payments you may be making, to any other expenses you may incur during the course of a regular month.
  
  Our maximum limit is 24 months of monthly expenses, for those clients who are very risk averse and require high amounts of liquidity. The average that most people decide to hold is 12 months of living expenses.
  
  We hope these rules of thumb will help you get a better understanding of how to structure your finances.
  
  Once again please note, if there are any specific circumstances for example being close to a life goal of retirement, child's education etc, then the rules of thumb may not be appropriate for you. They are meant only for general use and will not cater to any specific need you may have.
  
  For any specific situations it is necessary to consult your Financial Planner and operate on the basis of a complete Financial Plan.

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