7 MinsNov 24, 2020
Like most people you too want to invest for your future needs, buy adequate life and health insurance, own a house and car and plan for your retirement. But you are unsure how to go about it – what is the amount you need to save every month, how much loan should you take, what is the optimum insurance coverage, how much to set aside for retirement and so on. You could start by following these rules of thumb of financial planning. But remember, these are broad guidelines and you may need to adjust them as per your requirements.
10 rules of thumb for your financial planning and wellbeing:
(1) Save 30% of your take-home pay – Ideally, you should save 30% from your net take-home pay each month, before you pay for your expenses. This money should be deployed into productive investment avenues to fulfil your envisioned financial goals.
But this may not always be possible due to unexpected expenses. In such situations, you could make up the deficit in savings in one month by saving more the following month. Save in mutual funds through Systematic Investment Plans or in Recurring Deposits to ensure that you save money before you have the chance to spend it.
(2) Keep 12 months of unavoidable expenses as Emergency Fund - Broadly the calculation to build a contingency fund (also known as an emergency fund or a rainy day fund) is 12 months of regular monthly unavoidable expenses, including EMIs on loans (if any).
If you or your family members have a medical history, you may add 5%-10% extra for medical emergencies (taking cognizance of the health insurance cover) to the amount calculated using the above formula.
An Emergency Fund is a must for any household. Park the amount set aside for contingencies in a separate saving bank account, term deposit, and/or a Liquid Fund.
[Also Read: New to investing? Here’s how you can formulate your strategy]
(3) Have 10 to 15 times of annual income as life insurance – If you are the bread earner of your family, you should have a tem life insurance coverage of around 10 to 15 times your annual income and outstanding liabilities. No compromise should be made in this regard.
(4) Value of house should not exceed 2 to 3 times of your family income - We all endeavour to own our dream house. But don’t go overboard when availing a home loan. As a rule of thumb, the value of the house should not exceed 2 or 3 times your family’s annual income when buying on a home loan. However, you may need to make leeway due to the escalated cost of real estate and the possibility of home loan rates moving up.
(5) On-road price of car should not exceed 50% of annual income – If you are considering purchasing a car by availing a car loan; ideally the on-road price of the car should not exceed more than 50% of your annual income.
Also, as far as possible follow the 20-4-10 rule, wherein 20% should be the down payment; the car loan tenure opted for is not more than 4 years, and the EMI on the car loan is not more than 10% of your total annual income. If you do not have 20% the down payment money for the car loan, postpone buying the car.
(6) Education loan amount should not exceed expected first-year salary – To be successful, quality education matters. But the cost of quality education has gone up considerably. To ease the pressure of repaying your education loan, ensure that the loan amount is not more than the expected first-year salary when you join the organisation or your existing annual salary.
(7) EMIs should not exceed 40% of take-home pay - As a rule of thumb, the EMIs on all your loans should not exceed 40% of your Net Take Home pay. This is called the debt-to-income ratio. If you stick to this ratio, it will be easier to service your loans/debt. Borrow only as much as you can comfortably repay. If you have multiple loans, it is advisable to consolidate all loans into a single loan, that has the lowest interest rate and repay it regularly.
(8) Equity allocation should be 100 minus your current age - Many factors determine asset allocation, such as age, income, risk profile, nature and time horizon for your goals, etc. But you could broadly follow the formula: 100 minus your current age as the ratio to invest in equity, with the rest going to debt. And make sure you review your asset allocation.
Tactically, also allocate 5-10% of your investment portfolio to gold (preferably via Gold ETFs and/or Gold Saving Funds) with a long-term view, as gold is an effective portfolio diversifier, a hedge, and commands store of value during economic uncertainties.
(9) Do not ignore ‘Rule of 72’ – As per this rule, the number 72 is divided by the annual rate of return on investment to determine the time it may take to double the money invested.
When you invest to achieve the envisioned financial goals, make sure the return earned is attractive enough to counter inflation. Higher the return earned, lower will be the doubling period. That being said, never invest in avenues you do not understand well. Read up or seek professional advice to know more on the investment products before investing.
(10) Aim for 20 times your gross income as retirement corpus; generate 80% of income from savings – Retirement planning is an essential financial goal. To build a retirement corpus, aim to create at least 20 times your Gross Total Income at the time of your retirement. This is necessary to keep up with inflation.
Besides, take into account factors such as the following:
- The number of years left before you retire
- Your life expectancy (an estimate, based on your family’s medical history)
- Your current basic monthly expenditure
- Your existing assets and liabilities
- Contingency reserve, if any
- Your risk appetite
- Whether you have adequate health insurance
- Whether you have provided for other life goals
- Inflation growth rate
After retiring, follow the ‘80% of the income rule’. As per this rule, from your investments and/or any other income-generating activity, you need to generate at least 80% of the income you had while working. This will ensure that you can take care of your post-retirement expenses and maintain a comfortable standard of living. So make sure to invest in productive assets.
When you use the corpus from the retirement kitty, do not withdraw more than 4-4.5%. This is the ‘Bengen Rule’ .
Do remember that these are broad rules and what works for someone else may not necessarily work for you. Hence, do your research thoroughly before making any kind of financial investment.
Disclaimer: This article has been authored by PersonalFN, a Mumbai based Financial Planning and Mutual Fund research firm. Axis Bank doesn't influence any views of the author in any way. Axis Bank & PersonalFN shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.