Financial Planning Thumb Rules to avoid stress

 Professional Financial planning requires customised action plans based on assessment of financial status, risk profile, goals and periodic evaluation of plans. However, if you want Do It Yourself (DIY), you may adopt following 13 thumb rules to simplify the financial plans.  But remember, thumb rules only provide a general direction and may not necessarily provide you the exact solution.

1)How much to save:

  10 per cent of the post-tax income of those starting their career at around age 25 can be the starting point. Over the period of time, as the income increases, shoring it up to 15 per cent can give you a good head start and a buffer. As you grow older, and your income rises, and financial liabilities add up, make sure you are saving enough towards your goals. In middle age, saving at least 35 per cent of your post-tax income should be the benchmark.

2)The 50-20-30 Rule:

Confused about how much to save and spend each month? Here’s how to get started. It’s the 50-20-30 Rule, i.e., 50 per cent of your income should go towards living expenses, i.e., household expenses, including groceries; 20 per cent towards savings for your short, medium, long-term goals; and 30 per cent towards spending for Charity, Self-improvement, entertainment including outing, food and travel. The idea is to create outflow buckets for better control. Individuals may tweak the percentage according to growing age.

 3)The 20/4/10 Rule:

This rule helps keep your finances under control when you’re buying a new car. Twenty stands for the down payment amount, as 20 per cent of the car price should be paid by you. It’s, however, better to make as much down payment as possible. Four stands for the number of years of financing. Although lenders have a tenure of up to 7 years, it’s better to stick to 4 years. Ten stands for the ideal percentage of your net-take home salary that should go towards car loan EMIs.

4)Emergency fund:

As the name suggests, an emergency can happen anytime and needs immediate action. There could be a setback to one’s earning capacity due to a temporary disability or being unemployed for a few months. A medical emergency may crop up at a time and the settlement claim may take time, or the ailment itself may have a waiting period. In such cases, one may have to arrange for funds to tide over the situation. Whether it’s meeting the household expenses or honouring commitment towards EMIs.  Ideally 3-6 months’ household expenses, if you are single and have more secured job, 6-12 months expenses, if you have family and liability, as one’s emergency fund to face emergencies.

5)Life insurance cover:

One should ideally have a life insurance cover which is 7 to 10 times of your annual income. If you have other liabilities , add that liability amount to the cover.  The actual requirement may, however, depend on one’s age, goals to be achieved, financial dependent, accumulated wealth, etc.

The most cost-effective way of buying life insurance is through a pure term insurance plan. It is a low premium, high-cover protection plans where the premium goes entirely towards risk coverage, i.e., to cover the mortality risk. Therefore, on surviving the term, one doesn’t get anything back as there is no savings portion of the premium. But that should not deter someone from buying a term plan as risk cover through life insurance as it is one of the necessities in one’s overall financial plan.

6)Saving for retirement

Most of the financial planners suggest a retirement corpus target which is about 20 times of one’s annual income. Some feel that 30 times can be a better figure as it will take care of inflation. It gives you a reason to work backwards and estimate how much you need to save from today till you retire.

Still, this rule may leave you disappointed as it takes income and not expenses into account. Also, it may work for those whose retirement is years away than those who are retiring soon.

7)Loans EMIs

Don’t borrow as personal loan an amount on which the EMIs will be more than 40 per cent of the monthly take-home pay.

8)House price

By keeping three things into consideration, i.e., the take-home income, the down payment amount and the home loan interest rate, one can figure out the worth of the house that one can afford to buy. If one is buying a home with a down payment of 20 per cent and the rest on a home loan and keeping the income-to-EMI ratio in mind, the affordability arrives at about 4.5 to 5 times of one’s annual income. In other words, one is buying a house which costs about five times of his annual income. Therefore, when real estate prices go up, affordability becomes a concern, unless income also moves in tandem.

9)Home Loans

Don’t borrow as  Home loan where in the total EMIs including other existing EMIs on car or personal loans will be more than 45-60 per cent of the monthly take-home pay.

10)Investing in Equities

Percentage of investment in equity should be not more than 90 minus your age.  For example, if you are 50 year of age then your investment portfolio in equity should not be more than 40% (90-50).

 11)Required Net worth

Your required net worth, should be equal your age multiplied by your pre-tax income, divided by 10. That number, minus any money that you inherit, should be your net worth for your age and income.

So, if you’re 50 and make Rs 10 lakh a year, you should have a net worth equal to Rs 50 lakh, assuming you have no inheritance. If you want to secure your position as wealthy, your net worth should be double that number.

Remember, your net worth is your assets minus your liabilities, and your assets include not only your cash, but also jewellery, furniture but not your residential house.

12)Mutual fund portfolio diversification

When it comes to mutual fund schemes, many investors are known to hold as many as 30 different ones. Over-diversification may not necessarily help in obtaining the right result for the portfolio as per research most diversification benefits are obtained with about 10 funds.

13) Health Insurance

If you are single, staying in tier 2/3 city, you should have health insurance of 3-4 lakhs  basic health insurance cover and if you are in metro cities you should have insurance of 5 lakhs cover.

If  you have family and stay in tier 2/3 cities , have family floater health insurance of Rs 6-8 lakhs cover and if you are staying in metro city with family, have family floater health insurance of 10 lakhs cover.

Conclusion

Once you have made a start using the thumb rules, it is important to review things over time and make changes to your plan accordingly.

 Be wise Money wise

Kishore Hegde

Chartered Financial Analyst (ICFAI)

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