Nine rules of Personal Finance that every individual should know:
- Rule of 72 (Double Your Money)
- Rule of 70 (Inflation)
- 4% Withdrawal Rule
- 100 Minus Age Rule
- 10-5-3 Rule
- 50-30-20 Rule
- 3x Emergency Rule
- 40% EMI Rule
- Life Insurance Rule
Rule of 72
Definition: Number of years required to double your money at a given rate of interest.
Divide 72 by interest rate.
For example, if an individual wants to know the time it will take to double his money at 9% interest, divide 72 by 9 = 8 years
At a 6% rate, it will take 12 years
At an 8% rate, it will take 9 years
Rule of 70
Definition: The number of years the savings will be reduced to half its present value at a given rate of inflation.
Divide 70 by the current inflation rate.
For example, the inflation rate of 7% will reduce the value of your money to half in 10 years.
4% Rule for Financial Freedom
Definition: To take the VRS (Voluntary Retirement Scheme), the required corpus is 25 times the estimated Annual Expenses.
For example, if an individual’s estimated annual expense after 50 years of age is INR 500,000 and he/she wish to take VRS then the required corpus is INR 12,500,000.
Put 50% of this into fixed income & 50% into equity.
Withdraw 4% every year, i.e. INR 500,000
This rule works 96% of the time for 30 years of period.
100 minus age Rule
Definition: Percentage allocation of investment in equity should not be more than (100 – age) %
This rule is used for asset allocation to help determine the risk-taking capacity of the individual.
For example, the age of an individual is 30 years then 100 – 30 = 70
But if the age 60, 100 – 60 = 40
Definition: Return expectation from equity segment is 10%, debt segment is 5%, and savings is 3%.
One should have reasonable returns expectations
Equity and Mutual Funds – 10%
Debts and Fixed deposits – 5% Debts
Savings Account – 3%
Definition: The earnings should be allocated in the ratio 50:30:20 for Needs, Wants, and Savings respectively.
This rule helps an individual to better allocate (spend) the monthly earnings.
50% – Needs (Groceries, rent, EMIs, etc)
30% – Wants (Entertainment, vacations, etc)
20% – Savings (Equity, MFs, Debt, FDs, etc)
At least try to save 20% of your income, one can definitely save more than this percentage.
3x Emergency Rule
Definition: An individual should always have 3 times the fixed monthly income in the emergency fund.
An emergency fund should only be used in case of loss of employment, medical emergency, or any other catastrophic situation.
A better case scenario would be to have 6 times monthly income in liquid or near liquid assets.
40% EMI Rule
Definition: The total amount of monthly EMIs should not be more than 40% of the monthly income.
For example, if an individual earns INR 50,000 per month the total amount of all the EMIs should not be more than INR 20,000.
This Personal Finance Rule is commonly used by financial institutions to provide loans.
Life Insurance Rule
Definition: The assured sum should be at least 20 times the annual income.
For example, if an individual earns INR 1,000,000 annually the assured sum should be at least INR 20,000,000.
These personal finance rules are equally useful for individuals of any age.