One size may not fit all. But a few rules of thumbs in financial matters can help those who are starting out and planning on their own. While everyone’s situation is different, in the absence of an advisor, the broader rules can set you on track.
They may sound too simple but even investment advisors say that they come in handy. “If a do-it-yourself investor opts for rules of thumbs in financial planning, he can avoid grave mistakes,” says Deepesh Raghaw, a Sebi-registered investment advisor. Agrees Suresh Sadagopan, founder, Ladder 7 Financial Advisories: “They are short-cuts that help avoid investment decisions going wrong.”
While there are many broad-based principles, a few can help you get better organised. Here’s how to use them.
Budgeting for discipline: The 50-20-30 rule can help you budget your income based on necessities, savings and wants. According to the principle, 50 per cent of monthly income should be allocated to necessary expenditure such as bills, equated monthly instalments, etc. For financial goals, an individual should allocate at least 20 per cent, and the remaining 30 per cent can be used for discretionary expenses such as vacation and eating out.
What works: It helps a person get organised and inculcates discipline. Such allocation helps to create a balance among your obligations, goals and spends.
What doesn’t: Families that have higher monthly expenditure also need to save more to meet their future requirements. “When you are planning for the future, you look at your current lifestyle and calculate the corpus you would need to maintain it. Higher spends today also means, the family would need a higher percentage of savings,” says Sadagopan. Also, as income increases and liabilities go down, the percentage of savings should increase to 30 per cent.
Asset allocation to tide over volatility: One of the most popular rules for allocating to equities is 100 minus investor’s age. If the age of the individual is 35, he should allocate 65 per cent (100-35) to equities. Delhi-based software developer Nitin Garg followed this principle for five years when he first started his systematic investment plan in mutual funds. “After my daughter was born, I started taking higher equity exposure. The thumb rule helped me create a decent corpus in the initial years,” says Garg.
What works: A higher exposure to equities over the long term translates into higher returns. Many investors also make the mistake of investing in equities when stocks are doing well and they stay away when the markets begin to fall. The asset allocation strategy helps them invest in all market phases.
What doesn’t: Investments in different products depends on the amount required for the goal and the time frame. “For someone in his late thirties, a higher equity exposure could be required for children’s education and their marriage. A youngster staying with parents can also be 80-100 per cent in equities as he may not have responsibilities,” says Steven Fernandes, founder, Proficient Financial Planners.
Emergency fund depends on nature of job: A person needs to have six months of expenses in an emergency fund that can help him tide over a job loss or other emergencies that lead to loss of income. Kolkata-based Aniruddha Roy took the entrepreneurial jump two years back with just around three months’ expense in his bank. The business didn’t do well initially and he ended up using all the funds. “That’s when I realised that I should have had a bigger emergency fund and have started creating one,” says Roy.
What works: Instead of liquidating your savings, you have a fallback option.
What doesn’t: The amount of corpus a person needs varies with his situation. A double-income family can manage with a corpus that covers three months’ expenses. Investment advisors suggest that business owners should have a corpus worth one-year’s expense and those who are about to become an entrepreneur must cover for two years’ expenses. In case there are old parents, a separate emergency fund can also be created to cater to their urgent medical needs.
Life insurance is not just for income replacement: Life insurance cover should be 10 times the annual income to be adequately protected, according to a thumb rule.
What works: Many surveys have pointed out that most bread winners in India are under-insured. Getting life insurance 10 times the annual income gives a cushion in case the bread winner passes away.
What doesn’t: Life insurance should cover the expenses that the family would incur after the death of the bread winner, the liabilities and also the financial goals. For many, even 10 times may not be adequate if you add them all up.
Don’t underestimate retirement corpus: Many individuals start saving for retirement in their forties and end up compromising on the corpus that can help them lead a comfortable life. That’s why allocating 10 per cent of monthly savings for retirement can help.
What works: It’s difficult to ascertain the money that is required for retirement when a person is young, single or doesn’t have responsibilities. The 10 per cent rule helps you start early.
What doesn’t: While the 10 per cent rule can help you start with retirement savings, it may not be enough to meet post-retirement expenses. Typically, financial planners look at a family’s current expenses and calculate how much it would be when the person retires, accounting for inflation. Then they factor in a person’s life span to come up with the funds needed for retirement.