Thumb Rules of Financial Planning

Thumb Rule refers to a principle with its broad application which is not intended to be strictly authentic for every situation.

Updated: Wednesday, March 4, 2020, 13:10 [IST]

The phrase 'Thumb Rule' refers to a principle with its broad application which is not intended to be strictly authentic for every situation. Yet the term refers to the easily learned and applied procedure truly based on practical experience rather than a proved theory. In the case of financial planning, the application of thumb rule is likely to help individuals to reach their desired goal to achieve the intended financial freedom.

These rules of financial planning may help a youngster who has just begun their career to get some knowledge of basics to make a beginning of an elaborate path of financial journey and for those who are in the middle of their career and have not yet figured out a proper plan, these thumb rules may yield some support.

Analyzing the Financial Status

The very first step for financial planning is to analyze the current financial status. It is necessary to take stock of the current financial position by listing out all the assets, cash flow, liabilities, investments, insurance coverage, buffer capital and so on and understand core strengths of your finance and chalk out a plan for what can be accomplished for future.

Paying for Self

A certain part of your monthly income must be kept aside before spending. One should follow the golden rule of Income - Savings = Expenses and not the vice-versa.

As the sayings by the world's wealthiest person - Warren Buffet goes "Don't save what is left after spending; spend what is left after saving".

Firstly identify your goals, take into consideration the inflation-adjusted provision and then figure out as to how much you need to save today for securing your future. Make it a habit to move out your every month's income from your salary account towards your goals and try to administer the household expenses with what is left, in that way you will pay for self first.

Save For Retirement

Earlier keeping aside 10% of the monthly income would suffice you to build a retirement corpus for sustaining comfortable retirement. The lower rates of inflation and a defined pension are a thing of past. If you still stick on to the old rule, then it may not be enough to cover your soaring lifestyle and medical expenses.

Experts say that individuals should have a retirement corpus target of 20 - 30 times of one's current annual income. The higher the corpus amount, the better it will be to tame the rising inflation factor which keeps on growing year-on-year.

How much to Save?

This is one of the billion-dollar questions which every individual faces over their lifespan. As per the rule, at the beginning of the career, say at 25 years, one can start off saving around 10% of their post-tax income. Over a while, the same can be increased gradually taking it to 15 per cent, as per the rise in income level. At the middle age, it is better to shore up at least 35 per cent of your income after meeting tax cuts as the expenses at this point of time will shoot up heavily.

Emergency Corpus

As the name suggests, an emergency will come uninvited and needs immediate action. A medical emergency or any unforeseen event or financial crisis can crop up any time and hence it is mandatory to have an emergency corpus fund in place to tackle such situations with ease. Having an emergency fund in place will act as a safety net and is not aimed at reaching out a planned financial goal. This fund will come in handy if you are running out of household expenses or certain cash outflows or to honour committing towards your EMI's and so on.

Parking your funds which are worth at least 3 - 6 months of your household expenses in a fixed deposit or liquid fund will come in handy during financial distress period.

The 50-20-30 Budgeting Rule

The 50-20-30 budgeting rule is recommended to follow for fulfilling your necessities, wants and savings. As per the rule, an allocation of 50% of your monthly income (after paying tax) should be made towards meeting basic requirements, 20% to achieve financial goals in the form of investments and the remaining of 30% to meet your unrestricted expenses.

Some of the financial expert's advice, that savings should increase to 30% or even 40% if you are not having any EMIs. The higher salary figures drawn by the corporate employees should channel their earnings towards savings to enjoy a secured future.

Life Insurance

It is advised to have a life cover which is at least 10 time of your present annual income, The exact requirement may vary accordingly based on an individual's age, goals to be achieved, accumulated wealth, number of financial dependents and so on.

One should have a term insurance plan to financially safeguard the future of your dependents. One should not make a financial investment decision emotionally and should also avoid taking last-minute tax-saving investment decisions and hence planning will help you to avoid an erroneous decision.

The convenient way of purchasing life insurance is through a pure term insurance plan. Having a low premium, high cover protection plan wherein the premium amount goes completely towards risk coverage and hence on surviving the term, one will not get anything back as no savings portion of the premium amount is left out. But that alone should not stop you from buying a term plan which covers risk through life insurance as it is one of the necessities to attain an overall financial plan.

Conclusion

There is no standard approach when it comes to financial planning. Based on the situations and risk-taking ability of the individual a suitable financial planning has to be chalked out. And once you start using the thumb rule, it is important to inspect the things over some time and make necessary changes to the plan accordingly.

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About the Author

Archana is a Content Writer at GoodReturns. She has been writing articles related to investment planning and personal finance for more than two years.