In this article, we will discuss the Thumb Rule of Investing.
Thumb Rules of Investing
In terms of investing, there are certain thumb rules that help us ascertain how fast our money grows or how fast it loses its value. Then, there are rules to make our investment process easier. Like how should we do our asset allocation, how much to save for retirement & for emergencies etc. Various points to be considered before starting investing are:
1 . The Emergency Fund Rule
As the name suggests, the money kept aside for emergency use is called an emergency fund. It is a good practice to keep at least 6 months to 1 year’s expenses as an emergency fund.
While calculating your expenses you should include expenses for food, utility bills, rent, EMIs etc. & instead of keeping it idle in savings bank accounts invest these funds in liquid funds or in FD.
These funds provide a little more returns than savings bank accounts. At the same time, like saving banks accounts, liquid funds & FD are highly liquid, i.e. the money is available in very short notice.
2. 100 minus age rule
The 100 minus age rule is a great way to determine one’s asset allocation i.e., how much you should allocate in equities investment & how much in debt investment.
For this, subtract your age from 100, and the number that you arrive at is the percentage at which you should invest in equities. The rest should be invested in debt.
For example, if you are 30 years old and you want to invest Rs 8,000 every month. Here if you use the 100 minus age rule, the percentage of your equity allocation would be 100 – 30 = 70%. So Rs 5,600 should go to equities and Rs 2,400 in debt. Similarly, if you are 20 years old and want to invest Rs 8,000 every month, then according to the 100 minus age rule the equity allocation would be 100 – 20 = 80%. i.e., Rs 6,400 should go in equities and Rs 1,600 in debt.
3. The 10,5,3 Rule
When you invest or even think of investing money, the first thing that you usually look for is the rate of returns that you will get from your investments.
The 10,5,3 rule helps you to determine the average rate of return on your investment. Though there are no guaranteed returns for investments,
but as per this rule, one should expect 10% returns from long term equity investment, 5% returns from debt instruments & 3% average rate of return that one usually gets from savings bank accounts.
4. Not considering the impact of inflation on returns
One of the common mistakes that most investors tend to make is to ignore the effect of inflation on returns.
We all know that the value of the rupee is not the same as what it was 10 years ago. It’s worth was way more than what it is today. And after a few years, it will decrease even further. It’s almost inevitable.
In other words, inflation bites into the value of the rupee and decreases its purchasing power. So, while making any investment, your main aim should be to fetch returns that beat inflation.
5. 10% for Retirement Rule
When you start earning in your early or mid twenties, saving for retirement is the last thing in your mind.
But starting to save from your first salary, no matter how little the amount is, you will be able to create a huge corpus for retirement. Ideally it should be 10% of your current salary which you should increase by another 10% every year.
For example, If you are 25-year-old & earn Rs 30,000 a month. You have decided to invest 10% of your salary, i.e. Rs 3000, every month & increase it by another 10% every year. The retirement corpus you will be able create by investing in an instrument that provides 10% returns will be approx. to Rs 3.3 crores.
A great way to build your retirement corpus is by investing in NPS following the 10% rule.
| Current Age | 25 |
| Investment amount every month | Rs 3,000 |
| % of increase in investment amount every month | 10% |
| Average rate of return | 10% |
| Retirement age | 60 |
| Tenure of investment | 35 |
| Total retirement corpus | Rs 3.3 Crores approx. |
6. Rule of 72
We all want our money to double & look for the ways it can be done in the shortest amount of time. Well, calculating the number of years in which your money doubles is very easy with the Rule of 72.
Take the number 72 & divide it with the rate of return of the investment product. The number at which you will arrive is the number of years in which your money will double.
For example, If you have invested Rs 1 lakh in an investment product that provides you a rate of return of 6%. Now, if you divide the number 72 with 6, you arrive at 12. That means, your Rs 1 lakh will become Rs 2 lakh in 12 years.
7. Rule of 114
Like the ‘rule of 72’ tells you in how many years your money can be doubled, this rule tells you how many years it will take to triple your money.
Rule of 114 is similar to Rule of 72. For this, take the number 114 and divide it with the rate of return of the investment product. The remainder is the number of years when your investment will triple.
So, if you invest Rs 1 lakh in a product that gives you an interest rate of 6%, then as per the rule of 114, it will become Rs 3 lakh in 19 years.
8. Rule of 144
Two multiplied by 72 is 144. Hence, you can simply understand that ‘rule of 144’ helps you calculate in how many years your money will grow four times if you know the rate of return.
For example, if you invest Rs 1 lakh in an investment product that gives you 6% interest rate, it will become Rs 4 lakh in 24 years as per the rule 144. All you need to do is divide 144 with the interest rate of the product to calculate the number of years in which the money will grow four times.
9. Rule of 70
This is an excellent rule that helps you determine what your current wealth will be valued at 10 or 20 years down the line. Even if you do not spend a single amount from it (neither invest), it’s worth will be much less than what it is today. The reason is inflation.
To calculate this, take the number 70 & divide it by the current inflation rate. The number that you arrive is the number of years your wealth will be worth half of what it is today.
For example, If you have Rs 60 lakh & the current inflation rate is 6 percent. So going by the rule of 70, your Rs 60 lakh will be worth Rs 30 lakh in 12 years. For this, we simply divided the number 70 by 6 to calculate the number.
10. 4% Withdrawn Rule
If you want your retirement fund to live longer than you, then you should follow the 4% withdrawal rule. As a retiree if you follow the 4% withdrawal rule, it will ensure that you have a steady income stream.
At the same time, you have enough bank balance on which you earn enough returns. This rule also allows you to increase the amount owing to inflation. For this you can increase the withdrawal rate by the inflation rate.
For example – If your retirement corpus is Rs 1 crore & inflation rate is 6%. So if you withdraw Rs 4 lakh in the first year, you should withdraw Rs 4 lakh 24 thousand in the second year and Rs 4 lakh 49 thousand in the third year. i.e., every year you should increase the withdrawal amount by another 6% (inflation rate).
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