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There are some thumb rules in finance which can be quite cryptic for a noob in the investment world. Here’s a quick look at the most popular ones that you should know about. 

The 50-30-20 Rule:

This is a very comprehensive rule for managing your finances. It is very simple to put into practice. You will be required to make 3 chunks of your net income in the proportion of 50%, 30% and 20%. 

The 50% would be to meet your needs including household expenses such as rent, groceries, debt commitments, monthly utilities including electricity, gas, water and telephone bills, school fees, etc.

The 30% is for your wants which includes your discretionary spending such as vacations, luxury splurging, eating out and parties, shopping etc.

The remaining 20% is towards savings and investment. 

Inculcating this is not only simple and easy, but it is also an effective way to achieve your long-term financial goals by maintaining a proper balance within your monthly budget. In fact, it is a very simple way to segregate your monthly expenses seamlessly which could otherwise sound intimidating!

The 4% Rule:

This is a practical thumb rule which indicates that retirees should withdraw about 4% from their retirement corpus every year. This rule will ensure that there is a steady income and a sizeable corpus maintained for the rest of the years. 

The withdrawals (4%) represent the interest and dividends that one would earn on the corpus during the year. The conservative 4% is adjusted for inflation and possible taxes. 

The rule was based on historical data of stock and bond returns for a period ranging from 1926 – 1976 (50 years). While there are experts who propose that 5% p.a would be a better rule, it may not work during a worst-case scenario, there are others who are more conservative and propose a 3% p.a withdrawal given inflationary times and low-interest rate scenarios. 

However, the 4% p.a rule has remained popular over the decades, it is imperative to remember that life expectancy also plays an integral role in ensuring the sustainability of corpus during your lifetime. 

This rule however has a very strong underlying assumption, i.e. it assumes that 50% of the retirement corpus is invested in equity and the remaining 50% in fixed income or debt. However, this is not a full-proof retirement plan. There are other factors that you need to consider such as:

• Your entire retirement corpus and your asset allocation,

• Include all your sources of income,

• The applicable tax rate of the country,

• Your life expectancy after retirement.

Rule of 72:

We are always interested in doubling the money that we invest. This rule of 72 was introduced as a formula to estimate the years required for your investment to double at any given rate of return. Alternatively, if you have a timeline and the quantum of investment, it would give you the rate of return required to double your money within the timeline proposed. The formula for Rule of 72 is given by:

Formula:

Years to double your investment = 72 / Expected rate of return

This rule is reasonably accurate for investments which fall within the range of 6% - 10% p.a. This rule applies in investments where the interest is compounded over time and not for simple interest.

Usually, this rule doesn’t consider inflation, which is a very important factor as purchasing power reduces. and if the interest rate changes, then the entire amount needs to be recalculated.

However, the Rule of 72 can also be used to calculate the decrease in purchasing power because of inflation. If inflation is at 6% p.a., then in 12 years, the purchasing power would become half!

Rule of 10%:

There are multiple connotations to this rule:
 

EMI Commitment: A relatively simple rule for your EMI commitment, this remains the most effective and conservative means to manage your debt. At all given points of time, ensure that your net EMI commitment is lower than or equal to 10% of your net income. Managing your debt efficiently is one of the steps to achieving financial freedom and stress-free life.
 

Investing: You should start by investing a minimum of 10% of your investment on a monthly basis and then increase it by 10% on an annual basis.
 

Emergency corpus: 10% of your entire investment corpus needs to be kept handy for an emergency.