Money management is like cooking a tasty meal. You must identify the best ingredients, put them into the dish at the right time, and mix them in the correct ratio. Get any of these three steps wrong, and you will have a cooking disaster instead of a culinary masterpiece. And yet, cooking, like money management, isn’t an exact science. It’s an art, where from time to time one must go with what feels right to do.Here are some money management thumb rules that, broadly speaking, can improve your finances.
THE 1 WEEK RULE
Few things are more damaging to your finances than impulse spending. For impulsive buyers, here’s a thumb-rule: if a shiny, new thing has caught your eye, wait for one week. This gives you time to think the decision through. How useful will this purchase be? What’s the return on investment? What’s the resale value? Can this money be used in a better manner? If after a week you still feel strongly about the purchase, then go for it. But chances are, thanks to your careful scrutiny, you will realise you don’t actually need the item, and in the process prevent a wasteful expense.
THE 3% RENTAL YIELD RULE
A property you own should generate an annual rental yield of at least three per cent of the property purchase cost. For example, if property costs Rs 50 lakh, your annual rent should be at least Rs 1.5 lakh. This is a loosely applied thumb rule, and the actual rental yields may vary wildly from one location to another. But a good point of reference nevertheless.
THE 3X EMERGENCY FUND RULE
You must always own an emergency fund that’s at least three times your current monthly income. That’s the bare minimum. You can go up to six months and keep building if you feel the need to do so. This is up to you. This fund will keep you financially stable in emergencies such as loss of employment, urgent travel, repairs, etc.
THE 8% RULE
Before you make any long-term investment, ask yourself: will it pay you at least 8% returns per annum after taxes? If not, reconsider your decision to invest. The benchmark refers to returns from small savings schemes such as the Public Provident Fund, which currently provides tax-free returns of 7.9 per cent per annum on investments up to Rs 1.5 lakh per year. If your investment can’t beat PPF, then it may not be worth your while.
PAY YOURSELF 10% RULE
You are in debt to your future self. So make sure you clear this debt on priority each month without fail. Your 60-year-old self depends on you for his income. You should invest at least 10 per cent of your monthly income in long-term investments such as equity mutual fund SIPs and PPF in order to secure your retirement. Want to retire early? Invest more than 10 per cent.
THE 20X LIFE COVER RULE
If you are buying life insurance, make sure that your sum assured can take care of your family’s income needs for the long term. If you are in your 30s, the sum assured should be at least 20x your current annual income, or more if you can afford it.
THE 30% CREDIT LIMIT RULE
Try to keep your credit utilisation ratio (the percentage of your credit limit you are using) to 30 per cent for any month. For example, if your credit card limit is Rs 1 lakh, and if you spend Rs 30,000, your CUR is 30 per cent. Try and stay within this limit, because it will help improve your credit score.
THE 30% HOME BUYING RULE
Any time you buy property, you are going to pay at least 30 per cent (and normally around 40 per cent) of the property cost from your own pocket. Banks will typically finance up to 80 per cent, while you may need to fork out 30-40 per cent more for the down payment, costs of stamp duty and registration, furnishing, etc.
THE 40% EMI RULE
All your EMIs combined should ideally be no more than 40 per cent of your take-home income. For example, if your take-home pay is Rs 50,000, your combined EMIs should ideally be Rs 20,000. While few would stop you from going over this limit, you will strain your finances, lower your savings, and run the risk of defaulting on your EMIs.
THE 50-30-20 RULE
This is a ratio which says how much you should spend from your monthly income on fixed expenses such as rent (50 per cent), discretionary expenses such as eating out (30 per cent), and minimum savings and investments (20 per cent).
This ratio is ideal at the start of your working life. As your income grows, gradually flip your savings from 20 per cent to 30 per cent. As you age and your fixed expenses fall, your savings ratio should move from 30 per cent to 50 per cent, helping you secure your retirement.
These are rules of thumb — the most basic guidelines to better manage your money. Depending on your life stage, income, and life priorities, you may fine-tune these rules to achieve the best results. When in doubt, speak to an investment advisor....