Want to Create Wealth? Here are 11 Thumb Rules Each Indian Should Follow

Aug 01, 2018 | 11 months ago | Read Time: 3 minutes | By iKnowledge Team

‘The number one problem in today’s generation and economy is the lack of financial literacy,’ quoted Alan Greenspan. This is true. Once you complete your education, get your desired job and start making money, like yourself, most young professionals too are clueless about handling their income.

What is the optimal amount of savings? Are you spending more than you can afford? What are the most lucrative investment options?

These are just some of the many questions that arise when we try managing our finances. When you’re just starting out in your career, creating wealth for the future is probably not the first thing that comes to mind. But, it is advisable to have goals and chalk out a financial plan.

These rules will guide you to make a long-term financial plan. As individual needs vary, these are not a one-size-fits-all strategy so you must customise them to fit your requirements.

So, here are 11 rules that will give you a head start in dealing with your finances:

1. Income – Savings = Expenses

As Warren Buffet said, ‘Do not save what is left after spending, but spend what is left after saving’.

This is the basic rule of personal finance. Determine the amount you’d like to save first and set aside a part of your income as savings, before you plan your expenses, and not the other way around.

2. How much to save?

The savings you need depend on your life goals. The percentage of savings should ideally correlate with your age and career phase. At an early stage in your career, save at least 10% of your income. As you advance in your career and your income increases, raise savings to 15% and aim to save 35% around the age of 40.

3. The 50-20-30 rule

While saving 10% of income should be your minimum target, try to follow the 50-20-30 rule. As per this rule, earmark 50% of your post-tax income towards living expenses, 20% for savings and 30% for other leisure activities like vacations, eating out etc. This will help you adequately distribute your income towards all needs.

4. How much to invest in equity and debt?

High paying equity investments are riskier compared to debt. To effectively allocate your investments between the two, follow the 100 – age rule. That is, the percentage of equity in your portfolio should be 100 – your age. So, if you are 30 years old now, invest 70% in equity and the remaining in debt. You become more risk averse as you grow older, therefore the percentage of equity in your portfolio would reduce as start investing a higher percentage in less volatile debt instruments.

5. Contingency Fund

Maintain an emergency fund to meet unexpected expenses. The thumb rule is to have a contingency fund worth nine months’ income. But, this can take some time to build. So, start by setting aside enough money to sustain your needs for three months.

6. Life Insurance

The thumb rule says your life cover should be ten times your annual income. If you want adequate cover at a reasonable price, consider a pure term insurance. While it doesn’t provide any proceeds at maturity, it is the most affordable way of protecting yourself against risks. You can choose a policy for a desired term and pay regular premiums to enjoy its benefits.

7. How much to save for retirement?

Most experts believe a retirement corpus of 30 times your annual income is reasonable, if you wish to retire comfortably. Optimal savings vary depending on your income but it should be a significant amount to take care of your post-retirement needs. To build a sizeable retirement fund, have a target in mind and after factoring in inflation, work backwards to estimate how much you should start saving today.

8. Buying a house

To own your dream home, try to pay 20% as down payment. Also, ensure the total EMIs you pay do not exceed 50% and home loan EMIs stay under 30% of your income. In the current home loan interest rate scenario, you should be able to comfortably afford a house with a value of approximately 4.5 to 5 times your annual income.

9. Buying a car

When you plan to buy a car, first decide a budget and take a loan. The thumb rule to follow here is “20/4/10”. This means, you should make a down payment of 20%, repay the loan in 4 years with a maximum EMI of 10% of your monthly income.

10. Diversification

While diversification alleviates investment risk, don’t invest in more than 10 funds at a time. The marginal advantage gained from diversification is lost in the hassle of managing and keeping a track of your portfolio.

11. Net Worth

Your net worth includes your cash, investments, home equity, jewellery, furniture and other assets like artwork. To accumulate a good amount of wealth, aim for a minimum net worth of the product of your age and one-tenth of your annual pre-tax income.

For example, if you are 30 years old and earn Rs. 20 lakhs annually, your net worth should be at least Rs. 60 lakhs.

Conclusion

Note that these rules are almost standard but do not blindly follow them. Before applying these rules, consider your risk profile, inherited wealth, financial standing and modify them accordingly to align with your personal goals.

Advt. no.: IA/Jul 2018/4269


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