Thumb Rules of Investing
Amidst many questions related to investing, we often find ourselves confused and overwhelmed by the thought of putting our hard-earned money anywhere. We resist the idea of investment by thinking that our money is safe and sound in our bank accounts and there’s no risk involved.
But here’s the catch: Investing isn’t a problem. In fact, it is a solution to various life problems that you may face. The real trouble comes from putting your money into the wrong and risky funds. This is why it is important to have your investment planning in check whenever you make a decision about where to invest your money! And the many thumb rules of investing contribute a great deal to that.
In this article, we’ll provide you with a sense of understanding of the essential thumb rules that you should consider before investing. These rules can be your guiding principles. But just a quick heads up, they aren’t set in stone, so always trust your instincts before you dive into any financial decisions!
what is a thumb rule?
Before we jump into the thumb rules of investing, let’s clarify what a thumb rule actually is.
Think of the thumb rule meaning as a general notion that is considered to be correct, yet it isn’t proven to be so. The beauty of the rule of thumbs lies in its practicality. As they are tried and tested methods that have proven themselves over time, they are referred to as the golden rules of investing. The purpose of these rules is to help you in making well-informed decisions without becoming entangled in the complexities of the financial world. Now, without further ado, let’s jump straight into the rules!
Rule of 72
If you ever find yourself thinking, “When will my investment actually double?” Your answer lies in the Rule of 72.
It is one of the most famous thumb rules in investing. This rule serves as your quick way to gauge the time needed for your investment to double its value, considering a specific yearly interest rate. All you have to do is divide the number 72 by the annual interest rate of your investment. It will give you the approximate number of years in which your investment would double its value!
Let’s take an example. Say, you have invested Rs 5,00,000 and the estimated rate of interest is 9% per annum. All you need to do is divide 72 by 9, and you’ll get a close estimate of the number of years it would take for your money to double.
72/9 = 8
This implies that your money would double in 8 years.
This rule also comes in handy when you’re searching for investment opportunities. If you have a specific time frame in mind, you can determine the interest rate you need to double your funds. This information can guide your investment decisions effectively.
For instance, you want to invest rs 7,00,000 and you want this investment to double in 10 years. You simply have to put it in the formula –
Doubling time = 72/10 = 7.2%
However, don’t forget that this is a simplified approximation, but it is good to give you a rough idea of how long your money might take to grow!
Rule of 70
Inflation plays a huge role in our lives and yet people tend to overlook it sometimes when it comes to investing. The Rule of 70 helps you estimate when the value of your investment will be halved due to inflation. It is proved to be very valuable to find out the worth of your present wealth in a decade or two.
To calculate this all you have to do is divide the number 70 by the current annual inflation rate. This will give you the number of years it would take for your investment’s real value to decrease by half.
Let’s suppose, you have Rs 20,00,000 and the annual inflation rate currently is 4%.
70/4 = 17.5
This implies that in 17.5 years, your 20 lakh would be worth 10 lakh.
This rule emphasizes the need to account for inflation’s effect on your investments.
Rule of 114
This rule is similar to the Rule of 72 discussed above. Rule of 114 provides an estimation of how long it would take for your investment to triple in value based on the estimated annual interest rate. Just like you did before, all you have to do to get the approximate years is to divide the number 114 by the annual interest rate. Let’s take the same example as before
Your investment is Rs 5,00,000
The estimated rate of interest is 9% per annum. Years = 114/9 = 12.66
This implies that your money would triple in 12 and a half years.
Just like the rule of 72, this rule also comes in handy when you’re searching for investment opportunities and guides your investment decisions.
Rule of 144
Same as Rule of 72 and 114, the Rule of 144 helps you get the number of years in which your investment would quadruple. You only need to divide the number 114 by the annual interest rate. Let’s take the same example –
Your investment is Rs 5,00,000 The estimated rate of interest is 9% per annum. Years = 144/9 = 16
This implies that your money would quadruple in 16 years.
Just like the rule of 72 and 114, this rule will help you when you’re searching for investment opportunities and guide your investment decisions!
The 10 5 3 Rule
One of the first thoughts that cross our mind when we think of investing is, “How much wealth would my investments generate?”
Everyone worries about the rate of returns of their investment, but unfortunately, there is no definite way to accurately predict how any investment would turn out. However, the 10-5-3 rule can come close to the estimates as it determines the average rate of return on different types of financial instruments.
Following the 10-5-3 guideline, it is advisable to expect approximately 10% returns from extended equity investments, roughly 5% returns from debt instruments, and an average of 3% returns from savings bank accounts.
Also Read: What are short-term investments?
The Emergency Fund Rule
In an unpredictable world where things can suddenly change, having an emergency fund is really important. You never know when you may require some extra funds for unforeseen events like dealing with a job loss or a medical emergency.
People tend to rely on loans or liquidate their long-term investments to deal with emergencies, which is not an ideal thing to do. Therefore, before delving further into investing, it is considered essential to have an emergency fund.
The Emergency Fund Rule advises having six to eight months’ worth of living expenses invested in a low-risk fund. Emergency funds are highly liquid and they allow swift withdrawals without any delay. This fund acts as a safety cushion during unforeseen financial challenges, and grants you some peace of mind during distress.
The 10% Retirement Rule
No one in their mid-twenties really thinks about investing for their retirement. However, there’s nothing better than starting early when it comes to retirement planning.
When it comes to having a secure future, the 10% Retirement Rule has your back. This strategy is an excellent way to begin your retirement savings journey. This rule suggests that you should start to invest 10% of your current income and then increase it by another 10% every year.
Let’s suppose you’re 25 years old and your monthly salary is Rs. 30,000. Applying the 10% rule, you’d be investing Rs 3,000 every month and increasing it by another 10% every year. Assuming that the average return rate of 10% and your target retirement age is 60, the eventual amount saved would be around 3.4 crore. Isn’t that great!
The 4% Withdrawal Rule
Once you have enough savings for your retirement, the question is how do you make it last outlast you?
The 4% Withdrawal Rule suggests that you should withdraw about 4% of your retirement savings each year as it would guarantee a consistent flow of income without depleting your funds.
Let’s suppose you have 3 crore saved up for retirement. Applying this rule means that you should only withdraw 12 lakh every year. This would help you gain returns on the rest of your fund.
Also Read: How to Invest in SIP?
By following these thumb rules and investment planning, you can work towards a more secure future. Navigating through finances may be overwhelming, but with thorough research and good help, you can discover a path forward.
However, don’t forget that these thumb rules are meant to give you clarity and a sense of direction. They are not concrete. Consider all your investment options carefully and let a financial advisor guide you along the way!