Financial Rules of Thumb For Today

Spend less that you earn.

Risk only what you can afford to lose.

These are some of the most basic financial rules of life, rules that haven’t changed for years and probably never will.

These are rules that if you stick to, you are not likely to go wrong with your money.

Then there are other rules that have evolved with time. A changing financial landscape has necessitated an update to some well accepted rules of thumb that we use to manage our money.

Wanna know which ones? And why the change? Read on.

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It is important to remember that all of these are basic guidelines to help you. They are not absolute. Merely some rules of thumb to get your started. A further analysis of your specific situation may modify these.

OLD: Save 10% of your income for retirement.

NEW: Save 20% of your income for retirement.

There was a time when saving 10% of your income was enough to generate a corpus that was sufficient for your retirement needs.

But, with higher inflation, longer life-expectancy, improving lifestyles, higher cost of living and healthcare, this corpus is unlikely to provide a comfortable life after retirement.

Another problem with the 10 percent rule is that it does not consider your stage of life and how much you have already saved. If you have been busy repaying debt or are simply playing catch-up, 10% will not be good enough.

As a general rule of thumb, consider bumping up your retirement savings to 20% of your income.

Here is some further reading to help you save more.
1. Why Saving Money Is So Difficult & How You Can Start.
2. Pay Off Debt or Save? How Do You Prioritize?
3. 7 List That Help Save Money & Keep You Organized
4. Easy Ways To Cut Costs & Save More Without Impacting Your Lifestyle
5. Save on Your Food Budget On Your Next Family Vacation

6. Fun Need Not Be Expensive. Try These Fab Things.

OLD: In your asset allocation, 100 minus age is the proportion to invest in equities.

NEW: Allocate 110-120 minus age to equities in your portfolio.

One of the most basic principles of investing is to gradually reduce your risk as you grow older. In other words the proportion of debt in your portfolio should increase as you grow older, and equity should decline.

The general rule of thumb was that the proportion of equity in your portfolio should be 100 minus your current age. So, if you are 35 years old, you can hold 65 percent of portfolio in equities.

This rule has changed for a number of reasons. Firstly, life expectancy has increased. Second, the returns on debt have declined as compared to the early 1980s when interest rates were upwards of 10%.

As a result of these two, it is felt that with the old axiom of 100 less age may end up with less than the optimal amount of funds for their requirement.

The modified rule of thumb now is 110 minus your age for equities. And if you are a risk taker, then you can even take the allocation of equities to 120 less your age.

OLD: Have $1000 in your emergency fund.

MODIFIED: Have 3-6 months of expenses worth in your emergency fund.

When Dave Ramsey said to build an emergency fund of $1,000, people latched on to it as the gospel truth.

The fact of the matter is that a $1,000 fund for emergencies is just not enough. Even Dave Ramsey knows this.

What he says is to build a $1000 emergency while you are busy paying off your debt and don’t have much to spare.

So for clarity, let us change the rule to an amount equal to 3 – 6 months of expenses as your emergency fund.

3 months or 6 months?

There is no one size fits all answer to this question. It depends on your situation and the current economic environment.

  • Do you have high cost debt that you are repaying? In this situation, it is okay to have a $1000 – $2000 in your emergency fund.
  • Is your job stable? Think about how you feel about your job, its security, the growth in your company and the industry it is in, the demand for your skills, and the stability of your monthly income. If you feel comfortable about these then it may be okay to have 3 months’ expenses in your emergency fund. Else, aim to go to 6 months or even beyond.
  • Does your partner earn? Another factor to consider is if you are a single income household. In that case aim to build a higher cushion in your emergency fund. However, if your partner’s has a stable job, you may be okay with even 3 months worth of cushion.
  • You and your family’s health. How often do you need to go to a doctor or an emergency room? Are any of your family members on medication that need to be taken regularly or frequently, especially if it is not (fully) covered by your insurance. The more the risks, the higher amounts you need in your emergency cover.
  • The state of the economy is an important factor. In a downswing, you are likely to get laid off faster as well as take longer to find a new job. If you find trouble lurking, it is better to ramp up your emergency fund.

Decide your emergency fund amount based on the risks you anticipate. Needless to say $1000 fund is insufficient.

OLD: Insurance cover should be 10 times your salary.

NEW: Use a sliding scale to calculate a suggested amount of insurance cover.

The ’10 times salary cover as your insurance cover amount’ guideline was formulated with the intention to help your family pay off any mortgage or other debt you might have and to allow them some time to grieve without stressing about financial worries.

However, a 10 times salary as insurance cover is unlikely to replace your full income for them. To do so, you need to go higher especially at the beginning of your career.

If you are in your 20’s a good rule of thumb is to multiply your annual salary by 20 times as your insurance cover, provided you can afford it.

Later on, in your 40’s, when your income is higher and you are likely to have paid off a portion of your debts, an insurance cover of 15x is sufficient.

By the time you retire, have no debts outstanding, built up a retirement kitty and have met most of your financial goals, a 5x cover will do.

Are there any other financial rules of thumb that need to be tweaked with time?

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