Some Financial Thumb – Rules

Financial thumb-rules are rough guides for making sensible financial decisions .However they have their  infirmities and so need to be used in the right context.Following are a few basic financial thumb-rules:

  1. Pay yourself first rule: From any money you make, put away atleast 10% first before you pay any bills or debts or do anything else with the money i.e. make your investments the first obligation on your money.The general idea is that this money will start working for you by earning interest , gaining in capital value or giving you rents etc. and in time you will need to work less and less as your money starts working for you.
  2. The emergency fund rule: Build a corpus equal to 3-6 months worth of expenses of your household.Life is uncertain and you never know when somebody might meet with an accident , fall sick , suffer losses in business , lose a job or suffer loses due to fires or natural calamities ,war, civil strife etc.The money is to take care of immediate expenses,provide a cushion to fall back on till you find your feet again and if necessary provide a small stake to start over again.The money needs to be kept in a safe place where there is no chance of loss of capital and where it can be withdrawn immediately and without hassles.
  3. 100 minus your age rule:This is a thumb-rule to determine how much of your paper assets should be in equities.The general idea is that as you grow older and wealthier you want less volatility and less risk of capital loss.Volatility might complicate withdrawls from the corpus in retirement and lost capital might not be so easily made up for later in life, after retirement.
  4. The 10,5,3 rule : This rule states that you can on an average expect returns of 10% on equities,5% on bonds and 3% on liquid cash and cash-equivalent accounts in the long run.It’s important to remember this rule before reaching for that extra half percent that might lead to capital loss.
  5. Rule of 72:This is a rule of thumb you can use to find out how soon your money will double.For more details please refer to this previous post:
  6. Rules of 114 and 144:These rules are derived from the above rule.They help us estimate how many years our money will take to triple and quadruple respectively,given a certain growth rate. We just have to divide 114 or 144 by the interest rate to estimate the time required.
  7. Rule of 70:This rule too is a special case of Rule 5.It can be used to estimate how soon money will halve in purchasing power due to inflation.To use this thumb-rule just divide 70 by the rate of inflation.
  8. AAW rule(Average Accumulator of Wealth rule):AAW ,UAW and PAW are term coined by Thomas J Stanley and William D. Danko of ‘The Millionaire Mind’ and ‘The Millionaire Next Door’ fame.To check if you are an AAW multiply your age by your realized pretax annual household income from all sources except inheritances. Divide this by 10. This, less any inherited wealth, is what your net worth should be:if not you are an UAW and under saving.For more the fascinating works of these authors please refer to these previous posts: .The sample of millionaires these authors analysed was exclusively American.For India a divisor of 20 is considered more realistic.Or you could use a sliding scale linked to age.At age 40,someone earning 7.5 lakhs a year should have a net worth of 15 lakhs and for a 20 year old the divisor should be 25.
  9. 4% withdrawl rule:This is believed to be the amount which a person can safely withdraw per year from the retirement corpus invested in a conservative balanced portfolio and make it last for 30 years.

About Keerthika Singaravel

2 Responses to Some Financial Thumb – Rules

  1. Pierce White says:

    Interesting article.Interesting blog.

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