People will often say that the best career is one where you do something that you love. If this criterion is met, one never has to work a day in their life. Now, as feel-good and wholesome that sounds, what one likes and what earns one "good money" are often two separate tasks. This is why the distinction between a hobby and a job exists.
Fulfillment of these hobbies is what gives people a sense of satisfaction and accomplishment in life. However, the funds necessary to fulfill these hobbies are often sourced incorrectly. You see, people often use their salaries or primary incomes in a very exhaustive fashion to achieve this self-fulfillment goal.
A very important part of personal financial planning is to make your money earn for you. Because let's face it, most salaried individuals aren't paid nearly enough to sustain a comfortable lifestyle and people should not have to work their fingers to the bone to achieve the bare minimum in terms of survival.
While no one likes being told what to do, everyone can appreciate a little guidance from time to time. And when it comes to personal finance, sticking to a few simple rules can go a long way. Like any journey, there will be a few unavoidable adversities but with a little discipline, and a robust, yet flexible financial plan, most people will come out on top with a little more than some "spare change". So let's read about a few personal finance rules that you could use to improve your monetary standing.
Personal Finance Rules
While these rules are all-encompassing, this article will divide them into various facets of personal finance to make remembering them easier for you. Treat these aspects like checkboxes to give yourself a thorough approach to having all your bases covered.
1. 35-40% Rule for EMI
Let's get the big bad debt out of the way first. From mobile phones to vehicles to other assets, people often employ external finances to fund these purchases. While incurring debt itself is not such a big deal, it is over-exposure to debt that can severely harm one's finances.
The most common method of debt repayment is EMIs as people usually cannot repay the loan in a lump sum. EMIs are where the first personal finance rule comes into play. The rule states that a person's total EMI payment should not exceed 35-40% of a person's monthly income.
The aforementioned numbers are not a hard limit, but constantly exceeding the limit can cause a financial strain as an EMI is an obligatory payment and takes higher priority over other expenses. Having more than 35-40% of your monthly income taken away would naturally leave not a whole lot of breathing room for other expenses.
2. 15x Insurance Rule
People are often very unconcerned about insurance as it is a preparation against sudden adversity. Most people are of the strong, yet incorrect belief that they are "careful", and thus, do not need an insurance policy. What they tend to forget is that insurance is a safeguard against unforeseen mishaps or accidents, which cannot be forecast or known/prepared for beforehand.
Plus, insurance is not only useful for the person facing the accident, but also for the people dependent on said person. In case of an emergency where the primary earner is sent out of commission, insurance helps keep the family financially afloat for the foreseeable future or till a new source of income can be created for the dependent(s).
The rule for life insurance is to buy a life insurance policy that provides a cover amount equal to 15 times your annual income. So, a person who earns ₹10 lakh annually should buy a policy that assures a sum of ₹1 crore.
This ensures that the dependents of the insured have as much as 10 years (the period is usually shorter as inflation reduces the value of the sum assured as time passes), to sustain themselves before having to establish a new source of income.
3. 6x Emergency Funds Rule
There are situations in life that might not be as severe as death, but still affect the earning capacity of a person. Circumstances like injury, sickness or even unemployment (frictional or otherwise) can affect the earning capacity of an individual in a negative manner.
Situations like these and more, that aren't quite in the purview of insurance but still need preparation against, require the creation of emergency funds. Emergency funds are liquid funds that are not parked in any instruments. This makes them readily available for spending as and when the need arises.
The rule of thumb for emergency funds is to maintain a reserve equal to 6 times your monthly expense. This allows people to have a cushion to fall back on in case of sudden, unforeseen financial instability.
4. 50-30-20 Rule of Savings
Whoever said "Money saved is money earned", must have not heard of or forgotten about inflation. In today's economic environment, the appropriate way to look at things would be, "Money saved is money saved, money invested is money earned".
When it comes to saving money, it's not the act of saving money itself that is difficult; almost everyone is able to save up some amount of money from their income. The problem, however, is in how much money gets saved. You see, most people feel like their savings are insufficient. Now, a part of this deduction is just a feeling as everyone would like to have more money left in their possession after the necessary expenses are met.
There is, however, a minimum threshold that must be met in terms of savings. This threshold is mentioned in the "50-30-20 rule" which states that an individual should spend 50% of their income on their "Needs"(Rent, bills, EMIs, fees, etc.), 30% on "Wants" (Eating out, OTT subscriptions, outings, etc.) and 20% of one's income should be directed towards "Savings". Here, "Savings" does not mean just depositing money in a bank account, but using the 20% to invest as well in mutual funds, stocks, bonds and other investment instruments.
Speaking of investing, people invest for one major reason, and it is to generate returns. After all, investing is the only way to beat inflation and let a person's corpus maintain its value. A benchmark that people set for their return generation is the "doubling of funds", which is a valid goal. The "Rule of 72" helps investors find the time it would take for their investments to double in value. The rule states that in order to find the amount of time it would take for an investment to double in value is to divide 72 by the rate of return of the selected investment instrument.
For example, if the rate of return on an investment instrument is 10%, according to the Rule of 72 it would take 72/10, or around 7.2 years for any amount of money invested in that instrument to double in value.
5. "100 minus Age" Rule for Asset Allocation
Now that you've generated savings and have begun to invest, the next question is, what should be your portfolio split? Proper asset allocation is based on the investor's risk profile. As one grows older, their risk appetite reduces and their investments should reflect their appetites for the protection of their interests.
The "100 minus Age" rule helps people understand the ideal asset allocation based on the investor's age. Since equity is the riskiest asset class, using the 100 minus age rule, investors can determine the percentage of equity in their portfolio. For example, if an investor is 25 years old, using the 100 minus age formula, their portfolio should consist of 100-25, or 75 equity based instruments while the rest should be comprised of debt instruments.
Become a Financial Planning Expert
While the list above is pretty comprehensive, nothing says "Financial Planning Expert" better than a certificate by the BSE with your name on it. Another thing that's territorial with expertise is understanding that these rules are meant to be guidelines, not mandates. This means that these rules will apply differently to every person and their portfolios.
But if you still need some additional guidance and that aforementioned certificate, Quest by Finology has you covered with a fun two-part video course! The "The Fundamentals of Personal Finance" course by Quest has these rules covered in much greater detail as well as a course comparing Cash Flow and Capital appreciation by financial planning and investment expert Dr. Chandrakantha Bhat.
Closing thoughts
As parting words, all that investors should remember is the fact that these rules are supposed to be flexibly applied to every individual's finances. So changing a 70 to a 65 wouldn't cause a catastrophe or mess your finances up.
Your finances, your rules. Happy investing!
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