Rules to be kept in Mind
There are rules of thumb for everything. 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 in mutual funds, how much to save for retirement and for emergencies etc?
we will talk about the 10 most popular thumb rules in the world of investing.
First, let’s look at the 3 rule to understand how fast your money can grow
Rule of 72:
We all want our money to double and 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 and 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, let’s suppose you have invested Rs 1 lakh in a product that provides you a rate of return of 6 percent. 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.
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.
The mathematical formula for 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 percent, then as per the rule of 114, it will become Rs 3 lakh in 19 years.
Rule of 144:
Two multiplied by 72 is 144. Hence, you can simply understand that? rule of 144′ helps you calculate 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 a product that gives you a 6 percent interest rate, it will become Rs 4 lakh in 24 years as per 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.
Now, as much as it is important to understand how fast your money grows, it is equally essential to know how fast the value of your money diminishes.
Let’s look at the rule that helps you determine how fast money loses its worth
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 penny 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 and 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, let’s suppose you have Rs 50 lakh and the current inflation rate is 5 percent. So going by the rule of 70, your Rs 50 lakh will be worth Rs 25 lakh in 14 years. For this, we simply divided the number 70 by 5 to calculate the number.
And now that you know how fast your money goes up and down, let’s look at some other rules that help you in the investment process.
Let’s look at the 5 thumb rules you can use while investing
The 10,5,3 rule
When we invest or even think of investing money, the first thing that we usually look for is the rate of returns that we will get from our investments. The 10,5,3 rule helps you determine the average rate of return on your investment.
Though there are no guaranteed returns for mutual funds, as per this rule, one should expect 10 percent returns from long term equity investment, 5 percent returns from debt instruments. And 3 percent is the average rate of return that one usually gets from savings bank accounts.
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 six months to one year’s expenses as an emergency fund. While calculating your expenses you should include expenses for food, utility bills, rent, EMIs, etc. And instead of keeping it idle in savings bank accounts invest in liquid funds. These funds provide a little more returns than savings bank accounts. At the same time, like saving bank accounts, liquid funds are highly liquid, i.e. the money is available in very short notice.
100 minus age rule:
The 100 minus age rule is a great way to determine one’s asset allocation. That is, how much you should allocate in equities and how much in debt.
For this, subtract your age from 100, and the number that you arrive at is the percentage at which you should invest inequities. The rest should be invested in debt.
For example, if you are 25 years old and you want to invest Rs 10,000 every month. Here if you use the 100 minus age rule, the percentage of your equity allocation would be 100? 25 = 75 percent. Than Rs 7,500 should go to equities and Rs 2,500 in debt. Similarly, if you are 35 years old and want to invest Rs 10,000, then according to the 100 minus age rule the equity allocation would be 100? 35 = 65 percent. That means Rs 6,500 should go in equities and Rs 3,500 in debt.
10 percent for retirement rule:
When we start earning in our early or mid-twenties, saving for retirement is the last thing in our minds. 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. And ideally, it should be 10 percent of your current salary which you should increase by another 10 percent every year.
For example, let’s assume that you are 25 years old and earn Rs 30,000 a month. You have decided to invest 10 percent of your salary, i.e. Rs 3000, every month, and increase it by another 10 percent every year. Let’s calculate the retirement corpus you will be able to create by investing in an instrument that provides 10 percent returns.
So, simply by investing Rs 3,000 every month, and stepping it up by another 10 percent every year, you would be able to create a corpus of Rs 3.4 crore.
A great way to build your retirement kitty is by investing in NPS following the 10 percent rule.
The 4% withdrawal rule
If you want your retirement fund to outlast you, then you should follow the 4 percent withdrawal rule. As a retiree, if you follow the 4 percent 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.
For example, let’s suppose, you have a Rs 1 crore retirement corpus, and you should withdraw Rs 4 lakh from it every year, ie Rs 33,000 every month.
Now some retirees follow this rule for the entire retirement years, but the rule also allows you to increase the amount owing to inflation. For this, you can increase the withdrawal rate by the inflation rate declared by the reserve bank. Let’s understand this with an example.
Suppose your retirement corpus is Rs 1 crore, and the inflation rate is 5 percent. So if you withdraw Rs 4 lakh in the first year, you should withdraw Rs 4 lakh 20 thousand in the second year and Rs 4 lakh 41 thousand in the third year. That is every year you should increase the withdrawal amount by another 5 percent (which is considered as the inflation rate).
Finally, if you want to know whether you are wealthy, then follow this rule
The network rule:
Even to know whether you can be called wealthy, there is a simple mathematical formula.
For this, multiply your age with your gross income and then divide it by 10. If your net worth is equal or more than the remainder, then you can be called wealthy.
In India, the experts say the divisor should be 20 instead of 10. So for example, if you are 30 years old and your gross income is Rs 12 lakh, then your net worth should be at least Rs 18 lakh to be called wealthy.
This formula was used by Thomas J Stanley and William D Danko in the book? The next-door millionaire’ to determine how self-made millionaires made their money.
The rule of thumb or popularly referred to as thumb rule is an easy way to learn or apply things. And these practices are based on practical experiences. So as much as you can apply these things in real life and get results from it, these rules should never be considered as absolute truth.