7 Thumb Rules For Investing
By Mr. Harsh Jain, Co-founder, and COO, Groww .
Choosing the right investments and creating an investment plan that helps generate optimum returns can be overwhelming. There are various thumb rules that are used in investing. Thumb rules may provide great assistance but they should not be the primary reason why you invest or do not invest in any product. The catch is the expected interest rate. No investment product will be able to give you a cent percent guarantee of the interest rate it can offer in the coming years.
Nevertheless, thumb rules can serve as informational guidelines.
Thumb Rule #1: Rule of 72
Rule of 72 determines the number of years it will take for our money to double.
Let’s say that you invest Rs.1,00,000 with expected returns of 10% per annum. In how many years will the money double? According to this rule, if you divide 72 by the expected rate of return, you can get a fairly accurate estimate of the number of years your money can take to double. Therefore, Doubling Time = 72/Rate of Return
In the example above, the expected rate of return is 10% p.a. Therefore, Doubling Time = 72/10 =7.2 years Hence, you can expect your investment to double in 7.2 years. It is important to remember that this is rule is applicable in the case of investments that offer compound interest. You can also use the Rule of 72 to calculate the interest rate required for the investment to double in a set time frame. For example, if you want your investment to double within 6 years, Doubling Time = 72/Rate of Return Rate of Return = 72/Doubling Time = 72/6 =12% p.a.
Thumb Rule #2: Rule of 114
Using the same logic as the Rule of 72, if you want to determine the number of years your investment will take to triple itself, then you can use the Rule of 114. According to this rule, if you divide 114 by the expected rate of return, you can get a fairly accurate estimate of the number of years your money can take to triple. Therefore, Tripling Time = 114/Rate of Return If you invest Rs.100,000 with an expected rate of return of 10% per annum, then Tripling Time = 114/10 =11.4 years If you want your investment to triple within 6 years: Tripling Time = 114/Rate of Return Rate of Return = 114/Doubling Time = 114/6 =19% p.a.
Thumb Rule #3: Rule of 144
Using the same logic as the Rule of 72 & 114, if you want to determine the number of years your investment will take to quadruple itself, then you can use the Rule of 144. According to this rule, if you divide 144 by the expected rate of return, you can get a fairly accurate estimate of the number of years your money can take to quadruple.
Therefore, Quadrupling Time = 144/Rate of Return If you invest Rs.1,00,000 with an expected rate of return of 10% per annum, then Quadrupling Time = 144/10 =14.4 years
Hence, you can expect your investment to triple in 14.4 years. It is important to remember that this is rule is applicable in the case of investments that offer compound interest. If you want your investment to quadruple within 6 years: Tripling Time = 144/Rate of Return Rate of Return = 144/Doubling Time = 144/6 =24% p.a.
Thumb Rule #4: Minimum 10% Investment Rule
When we start earning, saving and investing is probably not the first thing on our minds. However, if you want to benefit from the power of compounding, then starting to save early is important. This investment rule says that investors should start by investing at least 10% of the current salary and increase it by 10% every year.
Thumb Rule #5: 100 minus Age Rule
The 100 minus age rule is designed to help you determine the asset allocation between equity and debt. According to this rule, you need to subtract your age from the number 100. The result is the percentage of equity exposure that can suit you. The balance can be invested in debt. This thumb rule works under the assumption that an individual’s equity allocation should reduce once they reach retirement. Let’s say that you are 30 years old and plan to start investing. Using the 100 minus age rule, the asset allocation of your portfolio will look like:
- Equity = [100 – 30] = 70%
- Debt = 30%
However, do your own due diligence and research before blindly accepting this or any other thumb rule.
Thumb Rule #6: Emergency Fund Rule
Life is uncertain, you need to be prepared for financial exigencies. Hence, most financial experts recommend young investors create an emergency fund before they start investing. According to this rule, you must put aside funds equal to your cumulative monthly expenses of at least 3-6 months. This can help avoid a crash crunch during emergencies. The emergency fund must be kept liquid and easily accessible during such emergencies.
Thumb Rule #7: 4% Withdrawal Rule
This is more of a financial discipline rule than an investing rule but it deserves a mention. Most people try to save for their retirement years and create a corpus that outlasts them. However, with inflation rates being unpredictable, there is a risk of burning through the corpus before time. The 4% Withdrawal Rule is designed for retirees to ensure a steady income stream without spending their savings at a fast pace. According to this rule, if you withdraw 4% of your retirement corpus every year, you will be able to manage your living costs. According to the rule, if you have a retirement corpus of Rs.1 crore, then to manage your living expenses, you must withdraw not more than Rs.4 lakh per year.
- Rules 72, 114, and 144 can be used to determine the period your investment can take to double, triple, and quadruple respectively.
- Follow the Minimum 10% Rule to get started with investing.
- Also, if you are beginning your investment journey, you might want to consider the Emergency Fund Rule.
- The 100 minus Age Rule is a way to allocate assets in your investment portfolio.
- Lastly, the 4%Wothdrawal Rule can be beneficial for retirees to ensure their financial independence outlasts them.
The thumb rules for investing mentioned above are guidelines that can be used by any investor. It is important to note that these rules are not to be followed blindly. Prudence is the hallmark of a successful investor and you must ensure that you research your options and talk to an investment advisor before you start investing. Remember, a good investment portfolio is one that works towards your financial goals while keeping your risk tolerance and investment horizon in mind.