Rule of 72
Suppose you are aspiring to buy a brand new car worth 20 lacs after 6 years. You have a corpus of Rs.10 lacs but you don’t know where to invest that will fulfil your requirement. You need to invest in an asset that will double your many within 6 years. The question comes ‘What is the required rate of return to achieve the target amount?’.
Rule of 72 tells that how much return you require to get your money doubled.
Formula: 72 / No. of years to double your money = Rate of return
(Putting on the values)
72 / 6yrs = 12%
Therefore to make your money double in 6 yrs, the rate of return required is 12%.
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Now suppose you are investing in an asset that is giving you a fixed return of 9%. To calculate the no. of years it would take to double your amount is:
72 / 9% = 8 yrs
Therefore it would take 8 yrs. to double your amount at the rate of return of 9% year to year.
The Rule of 100 – Age
“Never keep all your eggs in one basket”
We all know the need for diversification. The basic diversification commonly done by the investor is to put money in different asset class i.e., Equity & Debt to minimize the risk. But the question arises ‘what should be the ratio kept between equity and debt in a Portfolio?’
The common answer to the question is if the risk appetite is higher then more money can be kept in Equity whereas Debt is favorable if the prefer less risk. So risk is correlated to equity and debt but how can we relate it with age?
There is a simple formula which will tell you how much to keep in debt and equity in your portfolio.
The rules gives you the exact no. how much should you divide your money between equity and debt based on your current age.
Now say your age is 40 yrs. Then 100 – 40 = 60. So, 60% of your portfolio should be in Equity and 40% in Debt.
How the logic works?
It works on the basis of Risk appetite, Time horizon and your Goals. When a person is younger, his risk-taking appetite might be a little more because of which he can invest more in equity. As the age increases, time horizon decreases and so decrease the risk-taking appetite.
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Third rule that talks about your personal finance in a very simple way. Salary gets credited each month but how to utilize them i.e., how much to invest and how much to spend on basic needs.
Say your salary is Rs 10,000 after deducting all the taxes. You receive it in the form of Paid check. How much should you spend here?
There are two types of expenses. First is BASIC EXPENSES also called necessity that can’t be ignored. These include House rent, Grocery, petrol and many other important expenses that you can’t avoid. So 50% should be kept for these basic needs and try to go beyond it.
Second is WANTS. What are wants?
After basic needs there are certain expenses that can be avoided but don’t to maintain standard of living. To avoid that we might face inconvenience. So those activities that can be avoided with little inconvenience comes in Wants. For example: Movie tickets, Trip, shopping etc. These are the activities that is not basic needs but is required. Possible to leave with some inconvenience.
Out of total salary, 50% is taken out for basic needs after which 30% can be spent on your wants.
Now the rest 20% is very important for a common man. It depends on him what he does with 20%. The mistake many people make is to spend this money on wants however, this 20% must go on Savings and Investments.
Now two things come out in savings & investments. First to have an emergency fund. So that in case of emergency, you have some money to spare. Second, the money left should be completely used for Investment. Investment can be done on the basis of the two rules discussed above i.e., Rule of 72 and the Rule of 100 – Age.
We can see how these two rules are inter-related that can help to save and manage our personal finances.