5 Personal Finance Thumb Rules

A simple thumb rule is far more powerful than the complex and meaningless advice we tend to get in our day-to-day lives when it comes to personal finance. Here are some handy personal finance rules of thumb to help you get ahead financially, especially if you are new to financial planning.

Let’s explore each of them one by one:

1. Savings – The 50-20-30 Rule

Are you living paycheck-to-paycheck and finding it hard to estimate how much to save and spend each month? Here’s how to get started. Make use of the 50-20-30 rule.

It states that:

• 50 percent of your income should go towards living expenses, which includes household expenses, groceries, etc
• 20 percent should go towards savings for your short, medium and long-term goals
• The remaining 30 percent should go towards your flexible expenses, which include food, travel etc.

The idea is to create outflow buckets for better control. You may tweak the percentage according to your age, circumstances, etc.

Additional Reading: Savings vs. Investments: Do You Know The Difference?

2. Car Loan – The 20/4/10 Rule

Whether you are looking to buy a hatchback or a Sedan, Car Loans are a popular choice when it comes to funding your dream car. However, applying for an unrealistic Car Loan amount when buying a new car can leave you in a bit of a pickle, especially if a financial crisis strikes before it’s paid off.

This is when the 20/4/10 rule comes in handy. If you want to make the most of the car and the loan, this simple rule will help you keep your finances under control when you’re buying a new car.

The rule states that you should save at least 20% for the down payment amount, finance the vehicle for no more than 4 years and keep total monthly vehicle expenses – including principal, interest, and insurance – under 10% of your gross income.

Let’s explore each of these components in detail.

20: This is the percentage amount you need to make as a down-payment towards the loan. This figure ensures that you pay a sufficient amount initially and thereby decreases the total cost of your loan.

4: It refers to the tenure of the Car Loan. There are lenders out there who allow you to borrow for a tenure of 7 years as well, but that works more in the lender’s favour than yours. After all, the longer the loan tenure, the more you pay towards interest.

10: Ideally, this is the percentage of your monthly salary that should go towards the monthly instalment of the car. The lower the percentage, the better, since anything above that could easily put you in a debt trap.

3. Adequate Life cover

Life Insurance is a risk management tool that makes sure your financial dependants can set up an alternative income stream in the unfortunate event of your death. It can help them maintain their lifestyles for a reasonable period and meet their financial goals even in your absence. If you’re uninsured or underinsured, you are effectively exposing your dependants to the risk of not having enough to fulfil those objectives.

However, determining how much Life Insurance cover is adequate can be a little tricky. So, going by the rule of thumb, one should ideally have a life cover that is at least 10 times your annual income.  So, if you’re earning Rs. 10 lakhs per annum, your coverage should at least be Rs. 1 crore.

However, do keep in mind that Life Insurance needs are governed by many variables like age, income, assets etc., and consequently the one-size-fits-all approach doesn’t always work. Also, don’t forget to review your insurance cover every few years since needs tend to differ at different stages of life.

Additional Reading: Do You Know How Much Life Insurance You Need?

4. Home Loan

Planning on buying a house of your own? Although taking a Home Loan is now easier than ever before, don’t forget that a Home Loan is a long-term commitment and you need to be extra cautious when applying for one.

The rule of thumb says that your monthly Home Loan EMIs should always be less than 30 percent of your monthly income. For example, if you are earning Rs. 50,000 per month, then your monthly EMIs should not exceed more than Rs. 15,000.

Also, if you have other EMI obligations such as a Car Loan or a Personal Loan, your combined EMIs should ideally be less than 50% of your monthly income. As long as you stick to this rule, there’s no need to worry about high Home Loan EMIs that could put you in a debt-trap.

To ease out the whole process of getting a Home Loan, there are a few online tools that could help you find the best deal and make the process more convenient and stress-free. Don’t forget to check them out before applying for a Home Loan.

Additional Reading: Your Online Home Loan Toolkit

5. Emergency Fund

Whether it’s meeting routine household expenses or your commitment towards EMIs, certain cash outflows are unavoidable. An emergency fund is not aimed at meeting your planned goals but should act as a safety net.

Although there’s no fixed rule on how much emergency cash one should keep in his/her savings kitty, it is advisable that an amount equivalent of at least 3-6 months’ worth of household expenses should be in one’s emergency fund to help you combat financial emergencies with no stress.

Additional Reading: An Emergency Fund To Rescue Your Investments

Following these easy thumb rules will help you make informed decisions about your financial future. But remember, they only provide a general direction and may not necessarily give you the exact picture. So, when in doubt, it’s always a good decision to consult a reputed financial expert to plan your finances well.

Now that you’re all set to take the road towards financial planning, go ahead and start investing for a better and secure future.