You can find thousands of articles and blogs are written on personal finances, suggesting tons of money rules and strategies. No doubt, those rules and strategies yield success and help people to get their finances on track.
But, at times, it becomes difficult and confusing for people to follow the rules and advice given. Especially for the younger generation, those who have just started their professional journey. They struggle to find a good starting point that will serve as a base for a strong financial foundation.
For them, following the Rules of Thumb can come in handy for financial planning. These rules of thumb are well proven for every situation and are based on practical experiences.
I have listed some of the important and useful financial thumb rules, which will provide you with a direction and help you reach your desired goal.
Financial Rules of Thumb
Budgeting Rule- 50/30/20
The 50/30/20 budgeting rule is a rule for spending and saving. It helps you to divide your after-tax income and allocate it to spend.
The rule states, 50% of your income should be allocated for fixed and variable expenses. The next 30% for non-essentials (dining, entertainment) and the rest 20% should be kept for saving and debt repayment.
You can also increase the saving rate by reducing spend on non-essentials. Or, you can keep aside 10% of your income for building an emergency fund by reducing your spend on non-essentials.
Buying a Vehicle- 20/4/10
It is a popular car-buying affordability rule. The rule states, you should buy a car only when you can make 20% of the value of your car as a down payment.
Also, you should finance the car for no more than 4 years and your transportation cost should not be more than 10% of your income.
It helps you to avoid debt traps and keeps you from making any additional expenses on your car and transportation than you can afford.
There is another rule, known as the 10-year rule, which helps you to decide whether to buy a new car or an old one. If you want to maximize your car’s value, then either buy a used one or buy a new one and drive it for 10 years.
It minimizes the impact of depreciation. When buying a used car, the depreciation has already sucked the value out of the car. And, when buying a new one, using it for 10 years helps to optimize its value and the effect of depreciation is far less.
The homeownership rule calls for at least 20% down payment and home loan amount up to 4.5 to 5 times your annual income. It ensures you don’t buy a house that you cannot afford with your income level.
Additionally, your home loan EMIs should never be more than 30% of your monthly income.
And, the combined EMIs (home loan EMI and other loans EMI) should never cross 50% of your monthly income level. This also defines what should be your ideal debt-to-income ratio.
As long as you stick to this rule, the chances of falling into a debt trap will be very less and will make the whole home buying process convenient and stress-free.
Investing in equity- 100 minus your age
Not sure, how much should be your exposure to equities. Then you should follow the 100 minus your age rule for equity asset allocation. It is one of the earliest and elementary methods of asset allocation.
Following the rule, you will be able to gradually cut down the risks of equity investment as you grow older. For example, if your age is 40, then your equity exposure should not cross the 60% threshold and rest should be invested in high-grade debt instruments.
Rule of 72
Having a hard time to figure out how much time it would take to double your investment at the given interest rate. Then, you should use the rule of 72.
By the diving 72 by the rate of interest offered, you will get the rough estimate on how much time it will take. For example, at an 8% interest rate, the investment’s doubling time is 9 years.
6-months Emergency Fund Rule
The rule states, you should keep enough savings in your hand that can easily cover 6 months of expenses. This will help you in case of any emergencies arises and keeps you from taking any desperate decision that could worsen your financial stability.
As discussed above, the financial rules of thumb are pretty solid, reliable, tried and tested rules. And, in personal finance, they serve as a good starting point for financial planning. However, going forward you should do your research and go for personalized planning for more effective results.