I had written this post in February 2012. However, given a lot of reader emails on topics covered herein, I am re-posting it.
I use a few rules of thumb when it comes to how I manage my personal finances. Here are some rules of thumb that I practice for managing my own personal finances. I hope you will find some of these useful for your own purpose.
1. Rule of 72. The Rule of 72 states that you can divide the number 72 by whatever yield you are getting to see how long it would take for your investment to double.
For instance, if your fixed deposit earns an annual interest of 8%, it will take 9 years for your money to double (72/8).
2. The number one rule of saving money is: Pay yourself first. It’s very important to set aside your savings every month before you use the money for other things, including paying of bills. Always pay yourself before anything else.
The standard rule of thumb is to save at least 10% of your income. In this period of consistently high inflation, I believe a better goal is to aim for 20%.
Also, if you’re young, you can follow this rule of thumb – Save 10% of your income for your basic needs, 15% for comfort, and 20% to escape wherever you want.
3. When you’re saving money for retirement, the standard advice is save about 20x your gross annual income to retire. In other words, if you earn Rs 10 lac per year, you’ll need Rs 2 crore to retire. I think this rule won’t work in today’s environment because it focuses on income and not expenses (which are rising faster than the former).
I recommend a different rule of thumb: Base your retirement needs on 30x your current annual expenses. This assumes that you will live for 30 years post retirement. Of course, looking at the average Indian’s life expectancy of around 65 years, you may live lesser than 30 years post-retirement. But those additional years of savings will take care of the inflation that will see your annual expenses rise over the years.
4. Your emergency fund should usually cover 6-10 months of your household expenses.
5. Know your risk tolerance ‘before’ you begin investing. The time to decide how much you can afford to lose in the stock market is before a crash, not after one.
6. The widely regarded asset allocation rule of thumb is to have X% of your portfolio invested in stocks, where X is equal to 100 minus your age — with the rest invested in lower-risk investments like bonds. I believe this is an incorrect way to look at things.
A better way to look at asset allocation is to first answer this question – “Am I a stock or a bond?”
The answer lies in understanding yourself – your life, and your career.
You are a bond if you have a stable job that is unaffected by the volatility of the stock markets, and you have many years left to work.
On the other hand, you are a stock if you have little years of work ahead of you, or if you work in a volatile and unpredictable field that could decline quickly with little notice (like the stock markets itself!).
So if you are a ‘bond’, have a larger part (say around 60-70%) of your portfolio in stocks to balance it out. And if you are a ‘stock’, tilt your portfolio in favour of bonds (or similar instruments).
7. Your retirement should hold priority over your children’s college education. They can get education loans. Nobody will give you a retirement loan!
8. In terms of priority, save an emergency fund first, then pay off high-interest debt (like credit card debt and personal loans), and only then begin investing.
9. Cut your use of credit cards. If you’re not willing to buy a thing if you had cash, please don’t buy it just because you have a credit card.
10. If you get a windfall, use 1-2% to treat yourself. Put the rest in a safe place that will earn you interest and ignore it for six months. Allow the initial emotion to pass. Get over the initial urge to spend the money on a big house or a bigger car. Live your life as you had before. After you’ve had time to think about it, make your decisions.
Also Read: 25 Useful Financial Rules of Thumb
Dear Vishal,
Lucid and very apt. Simple and clear.
regards
Thanks for your feedback, Sudhir!
What to say? I am speechless. This is a perfect 10er. please continue to give us your valuable insights on Personal finance. This can be a perfect checklist for all of us to be financially disciplined.
Thanks for your feedback, Nakul!
Sometime back I read a similar topic in TFL but this gives a lot of refreshing ideas. Your ideas of retirement saving based on expenses instead of income is fresh and makes sense.
Asset allocation of “I am a bond or stock” concept should be brought to the masses. Although it is not as simple as asking a question “I am a bond or stock” and taking a decision. Whoever has read your 20 lessons, Lesson 17 describes that well with example. Thanks again for that 20 lessons, I can’t thank enough.
Save for our retirement first and If you’re not willing to pay cash…. are legends. Thanks for sharing.
@Mansoor
Bro going by d comment postings by you it seems you have finished reading all the 20 series of value investing guide by Vishal sir. Can you please forward those mails @ mealliance@gmail.com
What an article , Scores “Perfect 10” in my books.
Thanks Harshad!
Vishal you make things so simple!!
I believe this is why people like me look forward to your reading your posts and actually wait for them everyday!!
Thanks a lot!
Thanks for keeping your faith in me, Mayank! Regards.
This is something wonderful, I have ever read on personal finance in 2013 🙂
Thanks 🙂
Thanks Mihir!
Excellent article….was really useful…perfect timing for me because i’m in the process of setting personal finances in place.
Thank you Bharani!
it only takes 100 years of saving 20% of annual income to retire with 20 times annual income on the side.
Or, at the same saving rate (20% savings, 80% expenses), a mere 120 years before retiring with 30 times annual expenses.
At least, on the condition that your savings & income keep up with inflation! If not, it will take longer.
Sound plan, Vishal!
Hi Panly, rules of thumb need to modified to your requirements and must not be taken on face value. Thanks anyways for your view. Regards.
The article is short and sweet
Thanks Ram!
Dear Vishal,
Excellent rules of thumb and as always, simply and practically explained with current examples. Since having started last year I have been reading your posts with great interest. There has always been something of practical use in your posts and I thank you for that. This time, I particularly liked the expenses to retirement savings relationship algorithm. However, two questions please:
1)Thirty times today’s expenses work out to between 2 and 3 crores for me and I am married without children and already almost 40 years old. Is this rule for a 20 year old, unmarried chap without children? How does it change as one advances towards retirement?
2) I am a bit stumped when I think about how to ring fence the inflation beast in the retirement context: the more I read about it, the more heads it seems to sprout. How is this factored into your rules of thumb? For example, which is a good indicator of inflation in twenty years time, headline, core, retail, general, long term or consumer inflation? How can I be reasonably sure, 2-3 crores (20-30 times my current annual expenses) would be enough considering my family’s medical expenses (thank god, knock on wood etc.) are almost nil at the moment and our expenses are a reasonable 60-70% of my annual income?
As always, please keep up the good work. You are, like we say in South India, an elephant who probably little knows his own worth as he goes around helping people with their heavy lifting while asking for nothing in return!
Thanks Suhas!
1. Age will not impact setting aside 30x annual expenses for your post-retirement life. The number is assuming you will live 30 years after retirement. Given India’s life expectancy, living 20 years after retirement (or till around 80 years of age) is a comfortable assumption. But if you save money to last 30 years, you will also take care of inflation or any emergency cost that can arrive largely on account of healthcare needs.
2. Inflation is a difficult demon to capture. So the best way is to save as much as possible now and invest in assets that can beat inflation in the long run (largely equities / equity MFs). Of course, even if your do this, you can not be reasonably sure that you will have enough to cover your all retirement needs.
That’s why it is important to focus more on the process (saving and investing for max. gains) than the outcome. As they say, “To finish first, you must first finish.”
You have my best wishes! Regards.
You make life easier..!!!
Thanks Gaurav! 🙂
Dear Vishal,
The article is awesome…
I started reading about buffett & munger a year back and that lead to your website.
Its always a treat to read your articles.
Keep up the great work.
At the age of 26 i have built a portfolio of good stocks which is now valued at roughly 4 lakhs (1 times of salary).
I have 45k in liquid fund for emergency and i am saving 40% of my entry level IT engineer’s salary.
Is it ok to go 90% in stocks & 10% in cash?
Thanks Tanmay!
Invest a large part of that money in equities (direct + MFs) that you don’t need in the next 5 years or beyond. For any money that you need before that, please invest a large part in income-producing assets like FDs etc. Hope this helps.
great peace of writing…..
very helpful…..
Thanks Raj!