Dont Follow Thumb Rules Blindly

Hemant Rustagi
Chief Executive Officer, Wiseinvest Pvt Ltd.

One of the key factors that can help you keep your investments on track is to have a plan in place and a strategy to implement it. Besides, there are certain thumb rules to help you at different stages of your investment process. However, not all of them should be followed blindly. The key is to understand which ones suit your needs and which don’t. Here are some of the important thumb rules:

Rule of 72 ― This rule tells you the number of years required to double your money at a given rate. For example, if you want to know how long it will take to double your money at 8 per cent, divide 72 by 8 – it will take nine years. As is evident, the rule of 72 is one of the simplest tools to learn about accumulating wealth. Simply put, it helps you decide which investment options to choose and how much to invest to achieve your long-term goals like the education of your children and your own retirement planning. The flip side is that these returns are just an estimate and the actual return may vary depending on your asset allocation and how you monitor your portfolio.

Rule of 70 ― This rule tells you how fast the value of your investment will get reduced to half its present value. For example, if you divide 70 by inflation rate of say 7 per cent, the value of your money will reduce to half in 10 years. In other words, if education inflation is 10 per cent and the present cost of education is `50 lakhs, it will increase to `1 crore in seven years. This is a useful rule for predicting your future buying power and hence can be an important factor while planning for long-term goals.

4 per cent Rule for Financial Freedom ― This rule explains how much you should withdraw out of your retirement corpus each year. The 4 per cent rule is supposed to protect you from running short of funds in retirement. To make it work, you must accumulate a corpus 25 times your annual expenses. However, the 4 per cent rule doesn’t account for your non-portfolio income sources like pension and rent. Besides, the rule of thumb uses conservative assumptions. Retirees comfortable with more risk may be able to safely withdraw larger amounts of money each year.

100 Minus your Age Rule ― This rule helps you decide your asset allocation. As per this rule, if your age is 30, 70 per cent of your portfolio should be allocated to equities. While 100 minus your age rule makes asset allocation quite simple, there are quite a few drawbacks. The rule propagates that younger investors should invest more in equities and reduce exposure with age. The problem is that an investor’s personal circumstances and risk profile are not taken into account. For example, a younger investor with responsibilities and liabilities may not be able to invest a significant amount in equities.

Similarly, a retiree may be able to invest more in equities than envisaged by this rule. Besides, it doesn’t take into account the time horizon for goals to be achieved over short, medium and long-term time horizon. Hence, the portfolio could either become more conservative or take you beyond your risk-taking capacity. This rule also requires you to rebalance the portfolio more often than may be required in keeping with the time horizon of different goals. 

50-30-20 Rule ― This rule propagates that 50 per cent of your income should be allocated to needs (groceries, rent, EMI, etc.), 30 per cent to wants (entertainment, vacations, etc.) and the remaining 20 per cent to savings and investment. While the rule broadly helps you in understanding the importance of allocating resources to your needs, wants and savings in a manner that the present and future are not compromised, you must consider your personal situation and rework allocation accordingly. Of course, getting into a habit of investing regularly and increasing the amount on a regular basis can make a huge difference to your financial future.