What is an executor and what does it mean to...Read More
Recently, someone forwarded a well-meaning message to me on Whatsapp.
Here it goes:
9 Personal Finance Rules We Should All Better Know
1) Rule of 72
2) Rule of 70
3) 4% Withdrawal Rule
4) 100 Minus Age Rule
5) 10-5-3 Rule
6) 50-30-20 Rule
7) 3X Emergency Rule
8) 40% for Monthly Repayments Rule
9) Life Insurance Rule
1. Rule of 72
Number of years required to double your money at a given rate. You divide 72 by the rate of return. Example: If you want to know how long it will take to double your money at a return of 8% per annum, divide 72 by 8 and you get 9 years. At a 6% rate of return, it will take 12 years. At a 9% rate of return, it will take 8 years.
2. Rule of 70
Divide 70 by current inflation rate to know how fast the value of your investment will get reduced to half its present value. Inflation rate of 3.5% will reduce the value of your money to half in 20 years.
3. 4% Rule for Financial Freedom
Corpus required = 25 times of your estimated annual expenses. Example: If your annual expenses at 50 years of age is $50,000 and you wish to retire, then corpus required is $1.25 million. Put 50% of this into fixed income & 50% into equity. Withdraw 4% every year, i.e. $50,000. The chance that this rule works is 96% over a 30 year period.
4. 100 Minus Your Age Rule
This rule is used for asset allocation. Subtract your age from 100 to find out how much of your portfolio should be allocated to equities.
Suppose your age is 30. Hence (100 – 30 = 70).
But if your age is 60. Hence (100 – 60 = 40),
5. 10-5-3 Rule
One should have reasonable expectations about returns.
10% rate of return – Equity / Mutual Funds
5% interest rate – Debts (Fixed Deposits or Other Debt instruments)
3% interest rate – Savings Account
6. 50-30-20 Rule
Allocation of income to expenses. Divide your income into:
50% – Needs (Groceries, rent, mortgage, utilities etc.)
30% – Wants (Entertainment, vacations, eating out etc.)
20% – Savings (Investments, debts, fixed deposit etc.)
Try to save at least 20% of your income. You can definitely save more.
7. Emergency Fund Rule – 3X monthly income
Always put at least 3 times your monthly income in an emergency fund for emergencies such as loss of employment, medical emergency, car repair etc. In fact, one should have around 6 times of monthly income in liquid or near liquid assets to be on the safer side.
8. 40% on Monthly Repayments Rule
Never go beyond 40% of your income to service loans and mortgage repayments. If you earn $10,000 per month, you should not have monthly repayments of more than $4,000. This rule is generally used by finance companies to provide loans. You can use it to manage your finances.
9. Life Insurance Rule – 20X annual income
Always have a sum assured as 20 times of your annual income. Say you earn $100,000 annually. You should have at least $2 million insurance by following this rule.
Here Are Karen’s Views On Each Rule:
What do you think of the above list? Seems pretty comprehensive! Could be used by many as a starting template for making financial decisions for themselves.
Here are some of my views when I read them. (Warning: Some of what I say might be contrarian i.e. different from what many others in this field say. I would suggest you to understand both viewpoints and choose what you think is more logical):
Note On Rules 7 & 9: Most insurance agents around the world like to use the income replacement method because it is easier for them to calculate and sell more.
Bonus Concept To Be Aware Of:
Risk is a badly misused word in this field. Short-term volatility is seen as risk because many financial industry people want to buy and sell too fast – thereby “locking in” avoidable losses. That is the WRONG attitude for most investors. We would rather simply buy good assets, hold them, and let time do its job – while ignoring all the little price fluctuations along the way.
The rules cannot be applied on a ‘blanket’ basis to everyone. Your situation could be different from my circumstance. That means some of the rules may need to be tweaked to something more manageable and sustainable.
Whatever it is, please do not treat forwarded Whatsapp messages as the ‘bible’ of your personal finance knowledge. It is always advisable to cross check such information with your Certified Financial Planner.
I would recommend that you be familiar with these 8 Financial Ratios That Will Reveal Your Financial Health.