7 Rules of Thumb for Flawless Financial Planning

All of us have many segments to take care of and distribute funds when it comes to financial planning. May it be securing funds for peaceful retirement life, owning our dream house, travelling different corners of the country on our high-end bike or the latest SUV, or having adequate life and health insurance cover for us and our dependents. 

Wouldn’t it be good if someone gives us the right advice on financial planning at the right time, so we make the best financial decisions? We heard you! 

Here is the list of seven rules of thumb on various financial aspects so you can make the right financial decisions when the time comes.

1. Don’t let your education loan amount exceed the expected first-year salary

Pursuing the course of your interest at a reputed institution may look like a little out of the world for many of us. But, they may be worth it as they come with a lot of knowledge and exposure to the outside world. A merit student taking an education loan is a common sight these days as there are many education loan schemes offered by banks.

However, taking the loan is not the only important aspect here. Repaying the loan later should not turn out to be a burden. To keep things simple, make sure only to borrow an amount that is not more than the expected salary for the first year when you start earning. If you are already earning and would like to take a break for higher studies, keep the loan amount equivalent to your existing annual salary.

2. Make sure your EMIs don’t go beyond 40% of your take-home salary

Ensure the aggregate EMI you pay during a month does not exceed 40% of your monthly net income. Generally, this ratio is called the debt-to-income ratio. When you apply for a loan, lenders collect information on your current commitments to check if providing a new loan will still satisfy the debt-to-income ratio.

This is to ensure that you have enough funds to pay for your personal and family needs, and only 40% of your income goes towards debt repayments. The moral here is that you have to borrow only as much as you can repay.

3. Don’t eye on a car whose on-road price is more than 50% of your annual income

This rule of thumb applies if you are planning to purchase a car with a car loan. Further, try to plan your car purchase using the 20-4-10 rule where 20% should be down payment, the car loan tenure is not more than four years, and the EMI on your car loan is not more than 10% of your annual income. We recommend you to postpone the plan of buying the car until you save up for the down payment.

4. Let the value of the house you want to purchase be within 2-3 times of your family’s annual income

Owning a house is a common dream of many of us, and it will come true at some point in time. But when that time comes, don’t go overboard and borrow a lot more than you can afford. When you are buying on a home loan, see that the home’s value does not exceed 2-3 times of your family’s annual income. You may also need to consider the varying real estate rates and the home loan policies when you are at it.

Also Read: How to Handle Your Mutual Funds in 2021?

Going for a much bigger loan amount may be possible. Before you go for it, consider any misfortunes that may happen that might leave your family with a huge burden.

5. Have a life insurance cover equivalent to 10-15 times of your annual income

Are you the bread earned of your family? If yes, that gives you a lot of responsibility. To fulfil them, it is recommended that you have a term life insurance coverage that is equivalent to around 10-15 times of your annual income and liabilities. Compromising in this aspect may cost you and your family dearly at a later date.

6. Learn the power of ‘Rule of 72’

Rule of 72 says that you must divide the number 72 by the annual rate of return on investment to determine the number of years that investment product will take to double your investment. Check it out yourself.

Also, make sure the return you earn is good enough to counter inflation. Higher the return you earn, lesser will be the investment doubling period. We would also like to warn you not to invest in products that you do not understand with this in context. If there is an investment product, you do not understand completely, research on the product or get professional help in understanding it.

7. Try to keep your retirement corpus equal to 20 times your gross income

One of your financial goals must be retirement planning and building a corpus for post-retirement life. Though it may seem far-off, it is advised to start retirement planning well in advance so the corpus will have enough time to grow. 

Further, create a corpus equal to a minimum of 20 times your gross total income at the time of your retirement to keep up with inflation. It would be best if you also considered factors, such as 

• An estimate of your life expectancy based on the family’s medical history
• The number of years remaining for retirement
• Basic monthly expenditure
• Existing assets and liabilities
• Risk appetite
• Health insurance coverage available
• Inflation growth rate
• Emergency funds
• Funding required for any other life goals

You can follow another rule considering the post-retirement life, i.e. 80% of the income rule. The rule states that “Monthly income from investments or any other channels post-retirement = 80% of the income you had while working”.

This is to ensure that you have enough funds to take care of your expenses and lead a comfortable life after retirement. So, plan your investments accordingly.

Though these rules of thumb may not work for everyone, they can give you an estimate of how you can vary a few things here and there to build the right financial plan for you.

For any clarifications/feedback on the topic, please contact the writer at apoorva.n@cleartax.in