“It is better to be approximately right than precisely wrong” Warren Buffet
In financial planning there are several thumb rules that serves as broad guidelines for formulating strategies. Even though these canons of financial planning are useful, they need to be updated and aligned with the changing financial landscapes.
Let us examine following thumb rules that requires to be changed according to the present scenarios:
- Equity exposure in investing:
Old Rule: 90/100 minus your age is the ratio of equity investment.
New Rule: 110/120 minus your age:
Rationale/Assumptions: Increased life expectancy.
- Budgeting allocation of income:
Old Rule: 50-20-30 where 50% is general expenses, 20% is for goal oriented investments and balance 30 % for discretionary expenses.
New rule: in place of 20% saving 30% saving for goal-oriented investments or even 40% saving if we are not serving any loan EMIs.
Rationale/Assumptions: Increasing lifestyle inflation.
- Emmergency/Contingency fund:
Old rule: Should be equal to 3-6 months expenses.
New rule: corpus need to cover 9 months expenses which can be tweaked as per other factors like dependents and earning members in the family.
Now a days besides job loss of financial emergency it is common that people keep switching careers, take study or job skill upgrade breaks for which amount equivalent to 9 months expenses is recommended.
Suggested investment avenue:
The amount equivalent to three months expenses in liquid funds and rest in debt funds.
- Life insurance cover:
Old rule: 10 times your annual income.
New rule: 15-20 times your annual income if you are under 40 and above 40 years the 10 times your annual income. The rule may be tweaked taking into account other factors likes our loans, dependents, goals and lifestyle.
Rationale: Since in your income tends to grow rapidly you can not keep increasing your life cover every year to match our income.
Suggested avenue: Pure Term insurance plan.
Financial thumb rules are based on past experiences, common sense and wisdom. The thumb rules detailed in this post are precisely that and are intended to help with quick (approximately correct) solutions.
However, blindly following the thumb rules may be injurious to your financial health. While using these thumb rules, the we must also take into account and understand the rationale or assumptions behind each rule. Thumb rules provide a fine starting point or a reference on which you can build your final decisions.
Take right financial decisions!!!
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