The Top Thumb Rules of Investing You Should Know

Any new investor’s first hurdle is to make life-changing choices from thousands of investment options available in the market. The sheer amount of possibilities and associated risks could be overwhelming for anyone. By following certain time-tested thumb rules, you can simplify your decision making process, and learn how to save money, manage your investments and create wealth.

 

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What are the benefits of using the thumb rules of investment?

 

While investing may seem complicated for a beginner, it is not really true. All you need to do is follow certain thumb rules that act as excellent starting points and ease you into your investment journey.

 

These thumb rules provide easy and practical guidelines that will help you understand how to plan savings, or approach any financial goal or investment decision. 

 

It is important to remember that while these thumb rules are applicable in general, they may not be universally applicable to every investor and situation. 

 

While it’s necessary to have a job, it shouldn’t be your only source of income. Those interested in a secondary source of income through investing must first acquaint themselves with the thumb-rules of investing. This will help you build wealth from passive, secondary income. Let’s now discuss these popular rules of investing. 

 

How quickly will your money grow?

 

  •  Rule of 72

 

All of us want our investments to double in value and look for ways to do so in the shortest time possible. The good news is that the Rule of 72 will help you achieve this in the least amount of time.

 

It is a simple calculation that informs you of the time required for your money to increase. According to this rule, divide 72 by the rate of return. The number that you get is the number of years it will take for your money to double. 

 

Let’s assume you have invested INR 2 lakh in a product with a 5% rate of return. When you divide 72 by 5, you get 14.4 as a result. After 14.4 years, your investment of Rs 2 lakh will have grown to Rs 4 lakh. 

 

Try using different interest rates from other investment avenues and see how the procedure works.

 

  • 6%, it will take 12 years for your money to double [72 / 6 = 12]
  • 7%, it will take 10 years for your money to double [72 / 7 = 10.2]
  • 10%, it will take 7 years for your money to double [72 / 10 = 7.2]

 

The Rule of 72 is an eye-opener because of its practical utility. It encourages you to ask detailed questions before making significant investment decisions.

 

  • Rule of 114

 

The Rule of 114 takes the Rule of 72 to the next level. If you are not satisfied with doubling and are thinking about tripling your money through investment, you will have to use the Rule of 114.  Rule of 114 has a mathematical formula similar to Rule of 72.

 

Divide the number 114 by the rate of return. The remainder you get is the number of years. So, if you put Rs 2 lakh in a product with a 7% interest rate, it will grow to Rs 4 lakh in 16 years, according to the Rule of 114.

 

  • Rule of 144

 

Two multiplied by 72 is 144. The rule of 144 helps you calculate the number of years it takes for your money to grow 4x if you know the rate of return.

 

For instance, if you invest Rs 2 lakh in a product that gives you a 7% interest rate, it will become Rs 8 lakh in 20 years. 

 

Just divide 144 with the product’s interest rate to calculate the number of years in which the money will grow four times. 

 

As important as it is to understand how rapidly your money grows, it’s also necessary to know how quickly your money depreciates. We will be exploring this area with the Rule of 70.

 

  •  Rule of 70

 

This is an excellent rule to evaluate how much your existing funds will be valued in 10 or 20 years. If you did not invest anything, its worth would be lower due to inflation. 

 

To get this value, divide 70 by the current inflation rate. The figure you get is the period it would take for your money to be worth half as much as now.

 

Consider this scenario: you have Rs 40 lakh, and the inflation rate is 7%. According to the Rule of 70, your investment of Rs 40 lakh will be worth Rs 20 lakh in 10 years.

 

  • Minimum 10% Investment: The Cautionary Rule

 

Knowing the 10% investment rule is necessary as it will help you get through a bear market. If the price of an individual stock falls by 10% or more from what you initially bought it for, it’s time to sell the stock. 

 

Applying the 10% rule is vital for unfavorable markets. You are saving your time by not waiting for stock prices to recover. It teaches you how to be a street-smart investor, knowing when to sell and acquire shares. This investment principle, however, only applies to individual stocks.

 

  • The 10% Retirement rule

 

Planning for retirement will be the last thing on our minds when we are in our early or mid-twenties. However, if you begin investing from your first salary, no matter how small, you will be able to build a sizable corpus for retirement. And, preferably, it should be 10% of your present annual compensation, with an additional 10% growth per year.

 

For example, suppose you are 25 years old and earn Rs 30,000 per month. You chose to invest 10% of your monthly income, i.e., Rs 3000, and raise it by 10% each year. Let’s compute the retirement corpus you’ll be able to build by investing in a ten percent-returning instrument.

Sl No. Specific Details Answers
1 Current Age 25
2 Investment amount every month INR 3000
3 Percentage increase in investment amount every month 10%
4 The average rate of return 10%
5 Retirement Age 60 years
6 Tenure of investment 35 Years
7 Total Retirement Corpus INR 3.4 Crore

 

So, by merely investing Rs 3,000 per month and increasing it by 10% each year, you might accumulate a corpus of Rs 3.4 crore. Investing in NPS following the 10% rule is an excellent method to supplement your retirement savings.

 

  • What is the ‘100 minus age’ rule?

 

The older you get, the more you desire monetary security and the less willing you are to take risks.

 

The 100-minus-age rule states that the percentage of equity assets in your portfolio must be equal to the difference between 100 and your age difference. For example, if you are 29 years old, the rule recommends that you invest 71% of your income (100 – 29 = 71).

 

Essentially, the formula is based on the concept of the declining equity glide path, in which you reduce your equity allocation every year. As a result, you are protecting your portfolio from volatility. 

 

Does 100 minus age thumb rules will work?

 

The rule generalizes people’s risk preferences and is based solely on age. How would you apply the rule to a risk-averse person in his early thirties? The investment strategy must consider factors such as risk tolerance, time frame for achieving goals, and expectation of returns.

 

Let’s consider two friends, both of whom are 30 years old. Shyam was recruited on campus by a multinational corporation and has seen constant advancement in his job and compensation package. A well-established family with assets and properties, he is also unmarried. Ram, on the other hand, has been dealing with an unpredictable career, elderly and dependent parents, family loans, and the obligation to repay and settle a loan from a relative in three months.

 

If the ‘100 minus age’ rule is followed, they both must invest 70% of their wealth. Though it is not much of a challenge for Shyam it may be for Ram. This is because the latter has numerous commitments to meet and cannot afford to lose any of his investments. 

 

  • Emergency Fund Rule: Keep 3-6 Months’ Spending in Emergency Savings

 

New investors are frequently encouraged to first create an emergency fund. One must be financially prepared for unforeseen circumstances such as automobile breakdowns, medical bills, or unexpected unemployment. If they do not have a financial cushion, people may be compelled to go into debt or delve into long-term investments to fund these expenditures.

 

Why Does Emergency Fund Rule Work?

 

Setting aside money to deal with unforeseen events is a necessary component of personal finance. After fulfilling the primary obligation, one can make headway towards other financial objectives, such as debt repayment, retirement savings, or investing for future education. 

 

Three to six months’ worth of savings is a good starting point for the emergency fund rule. Individual risk tolerance varies, but retains financial buffers closer to 12 months’ worth of expenditures. This makes it simpler to fund any unanticipated needs without liquidating financial assets at an inconvenient moment.

 

Unemployment is a pressing issue for many people throughout the world. It can take many months for a laid-off worker to find a new job, especially in an environment like the coronavirus, which has forced many businesses to close. At that time, the emergency fund can help an individual.

 

  • The 4% Withdrawal Rule (can go upto 6%)

 

If you want to prepare for a financially secure tomorrow, you should know the ideal withdrawal ratio. If you plan to set aside money for retirement, follow the withdrawal rule. You can check the amount you require for retirement with the Retirement Calculator.

 

The withdrawal rule stipulates that you should not withdraw more than 4% of your retirement fund in just one year. 

 

 Assume you have accumulated Rs. 2 crores for your retirement life.

 

The 4% requirement requires you to draw just Rs. 8 lakhs a month. 

 

Inflation is another area of concern that influences your investments. Assume the annual inflation rate is 6%. You might increase your withdrawal by 6% every year to account for inflation.

 

  • The 50-20-30 rule

 

You can proceed by saving 10% of your after-tax income. After some time, however, you should target the 50-20-30 Rule of saving. That is, no more than 50% of your income should be spent on living expenses, including household expenses, no less than 20% should be saved for short and long-term goals and no more than 30% should be spent on avoidable costs, such as outings and vacations.

 

  • The Net worth rule

 

Thomas J Stanley used this mathematical formula and William D Danko in their book ‘The Next Door Millionaire’ to determine how self-made millionaires made their money.

 

There is an easy way to calculate how wealthy you are. To do so, multiply your age by your gross income and divide the result by ten. You are considered wealthy if your net wealth is equal to or greater than the remainder.

 

Experts in India believe the divisor should be 20 rather than 10. For instance, if you are 30 years old and your total salary is Rs 12 lakh, your net worth must be at least 18 lakh to be considered wealthy.

 

Key Takeaways

 

It is recommended to monitor asset allocation in terms of risk profile and goals rather than age. Bear in mind that stocks investment take a long time to provide the expected returns. If you only have a limited time to achieve your goals, consider debt investing.

 

There is no universal rule for variables like your risk tolerance, time to achieve your goals, and age. However, you might make approximate selections by aligning your objectives with the nature of assets. After allocating assets all at once, you cannot be passive. Keep track of asset performance and, if it is not in line with your aims, rebalance the asset allocation periodically.  

 

Some financial rules of thumb never go out of style. When combined with excellent investments, these standards will keep you financially secure.

 

Conclusion

 

Bear in mind that there is no one-size-fits-all remedy to improve your financial situation. The thumb rules mentioned here should be a starting point. After which, adjust them depending on your risk tolerance, inherited wealth, and personal goals. Before you invest your money, you must first understand why you are doing so.

 

The thumb rules of investing are founded on real-world experiences. So, while you can use these rules in everyday life, they should never be considered absolute truth. Understanding the nuances of how they can—or cannot—support a portfolio strategy, will help you to use your investments optimally. You can always take help from financial experts like Kuvera if you want to make wise investment decisions.

 

FAQs

 

  • What’s the no. 1 thumb rule of investing?

You should invest 30% of your monthly salary in dividends for your future generation. After which, 30% can be invested with equal allocation to equity and debt components. 30% of your retirement funds should be invested in income-generating debt schemes.

 

  • What thumb rule of investing must be used to calculate ROI?

Use the Rule of 72 if you want to measure the returns of your investment at a future date. 

 

  • What is considered a good annual rate of investment?

If you are getting an interest rate of 10% or more in your long-term investments, you will be able to cultivate significant growth in the future. 

 

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