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Thumb rules are informal piece of practical advice providing simplified rules what apply in most situations. They are not approximations and do not take into account the individual circumstances and needs of a person, so they may not be applicable to your particular situation. They are general principles that give practical instructions for accomplishing or approaching a financial goal.

1. Rule of 72

Time take to double your corpus.

The Rule of 72 is a simple, quick, and handy formula used in finance to estimate how long it will take an investment to double in value based on a fixed annual rate of return.

For eg: with 9% interest it will approximately take 8 years (72 / 9) to double your corpus.

2. 4% Rule

Withdraw 4% from your retirement corpus every year.

As per Investopedia it is a retirement planning rule of thumb that dictates a retiree withdrawn 4% of their retirement funds in their first year and remove that amount adjusted for inflation every year for retirement period of 30 years.

The 4% Rule is based on historical data on stock and bond returns in USA over the 50-year period from 1926 to 1976, focusing heavily on the severe market downturns of the 1930s and early 1970s. It is meant to provide a balance between enjoying your retirement and ensuring your money lasts for a typical 30-year retirement period. The rule assumes a mix of stocks and bonds in your investment portfolio.

It’s important to note that the 4% Rule is a guideline, not a strict rule that will guarantee your financial security. The actual success of the 4% Rule can vary depending on factors like market performance, your specific portfolio allocation, and the length of your retirement.

3. 10-5-3 Rule

Useful investment tool for investors to determine the average rate of return on investment for long period.

This rule states that long-term annual average returns on stocks is likely to be 10%, the return rate of bonds is 5% and cash, as well as liquid cash-like investments, is 3%.  This rule is suitable in the case of long-term investments, which could range from a timeframe of about 15-20 years. Therefore, this rule could be suitably applied in creating a corpus for a retirement portfolio.

4. 50-30-20 Rule of Budgeting

A simple guideline for building a budget.

Making a monthly budget is the first step in directing your income toward your short-, medium-, and long-term goals, and the 50-30-20 rule is the first step in making a budget. As per this rule 50% of monthly income should be spent on essential needs. These are the basic, non-negotiable expenses you must cover to maintain your lifestyle.  30% of the monthly income should be kept for wants or non-discretionary spending like travelling or entertainment. 20% of the month income should be kept aside as savings and debt repayments.

5. Asset Allocation (100 – Your Age)

Individual’s asset allocation of their investment portfolio.

The rule suggests that you should subtract your age from 100 to determine the percentage of your portfolio that should be invested in stocks or equities, with the remainder being invested in less volatile assets like bonds or fixed-income investments.

For eg: If you are 35 years old. So, your allocation to equities should be 65% (100-35= 65) and 35% in debt.

6. 3x Emergency Rule

Minimum amount to be kept aside for emergencies.

The 3X Emergency Rule is a guideline for determining how much money individuals should save for emergencies. It suggests saving an amount equal to three times their monthly expenses to cover unexpected financial needs such as job loss or medical expenses. You can move up to six months and keep building if you need to do so.

For eg- If your monthly expense is Rs. 30,000. So you should have 3x your monthly expense Rs. 90,000 as your emergency funds.

7. 40% EMI Rule

To determine maximum portion of monthly outlay on loan repayments  

The “40% EMI Rule” is a guideline used in personal finance to help individuals determine the maximum portion of their monthly income that should be allocated to loan repayments, specifically Equated Monthly Installments (EMIs). EMI is a fixed payment made by borrowers to lenders, usually for loans such as home loans, car loans, or personal loans. This rule is aimed at ensuring that people do not overcommit their income to loan repayments, leaving enough room for other essential expenses and savings.

For eg: If your monthly income is 1 lakh, then EMI should not be more than 40,000.

8. Life Insurance

Take cover of 20x Annual Income

The “20x Life Insurance Cover” is a concept that suggests having a life insurance policy with a coverage amount that is 20 times your annual income. This rule of thumb is often used as a starting point to help individuals determine an appropriate level of life insurance coverage to provide financial protection for their dependents in the event of their death.

For e.g: If your annual income is 10 lakhs, then life insurance should be around 2 crores.

9. Increase EMIs Annually

5% increase in EMI every year will reduce loan tenor by 8 years.

Increasing the EMIs once a year by a certain percentage as per your saving ability help you to repay loan much before the original tenor of the loan. It will help you save the interest payments.

For instance, a 20-year home loan can be repaid in 12 years – tenor will reduce by 8 years – if you increase your EMI 5 percent every year. Similarly if you increase the EMIs by 10% every year then you will end up paying loan in less than 10 years.

10. Prepayment of loan is beneficial in early years:

Prepaying a loan when it is new can be beneficial in terms of reducing overall interest costs and accelerating debt reduction.

If you have taken a 20 year loan and pre-pay 10% of the outstanding amount in the 2nd year itself, the loan tenor will be reduced by 42 months.

Photo by Pablo García Saldaña on Unsplash

Cinnamon Wealth

Author Cinnamon Wealth

"Catalysing Financial Freedom" Cinnamon Wealth curates solutions for Women & their family's unique financial needs.

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