I am going to talk about the 3 simple rules that every investor should be aware of . These 3 rules sound easy but can play a very important role in improving your investment. and talk about the first rule which is very important to you as an investor . say you have 10 lacs in hand and are thinking of investing it. but you don’t know which assets to put it in which fulfills your requirements. First, let’s talk about the requirements. If you have 10 lakh today. after 6 years you want to buy a car for 20 lakhs. so to get 20 lakh rupees you will have to invest in such an asset which will double your money in 3 years. Now the confusion here is what is my required rate of return. How will I know in how many years my money will double itself.
The first rule is Rule 72. It determines how long an investment will take to double at a rate of return. Now I would want to break it up and explain it to you in a simple manner. This rule tells you if you divide your return with 72, the return from your investment is equal to the years taken to double your money. Now say you are going to invest in such an asset which you think will give you a fixed 9% return in a few years.
if you have an asset which indicates your fixed return at 9%. this rule can directly tell you the years taken to double your money. Like 72/9 = 8, which means in 8 years your money will get doubled if you invest in an asset with min 9% return. year on year. I will go back to my first question, I want to buy a 20 lakhs car after 6 years with Rs 10 lakhs now. which means I want to double my amount in 6 years, the return required here would be 72/6=12. means if you want to double your amount in 10 years, you will have to invest in an asset/stock/mutual fund. which gives you an annual return of 12 %.
This rule helps a lot in your decision making, you can quickly calculate and see in the coming years. What are your requirements, in how many years you want your money doubled. what should be your required rate of return according to it. cause if you know what your required rate of return is then you can even estimate your risk, both are linked. but I would prefer that first you see your risk and then assess which asset should you invest in. For mental calculation, 72 rule can be useful for any investor which is very simple. I will recap it again. 72/Rate of Return = No. of years taken to double your money
let’s talk about the second question which comes to an investor’s mind when he starts investing. this question is it is said how important it is to diversify while making a portfolio. If I talk about basic diversification, what major investors think of is how much to keep in Equity and Debt. so that you can diversify and your risk gets neutralized for equity investment. but the big question faced by investors is how much he should invest in Debt and how much in Equity. Anybody can tell you if your risk-taking capability is high then keep more of your investment in Equity. and to take lesser risk put more in Debt. Risk is directly correlated to equity and debt but how can we relate it with age.
A simple formula which will tell you how much to keep in debt and equity in your portfolio. 100 – age formula directly answers you in terms on no. on how much can you invest in debt and equity. Now say your age is 30 years then 100 – 30 = 70, it says that 70% of your portfolio should be in Equity and 30% of your portfolio should be in debt. Another example, say if someone’s age is 60, then 100 – 60 = 40.so this 40 says that 40% of your portfolio should be equity and 60% in debt. This simple rule tells you on how your investment portfolio should look like. If we talk about the logic behind it then From the first example I took of 100 – 30 when his age was 30, he was asked to keep 70% of portfolio in equity.
When a person is younger, his risk-taking appetite might be a little more. because of which he is asked to invest more in equity. but as the age increases, time horizon to invest and risk-taking appetite decreases. Like we took the example of age 60 years, which asks to keep 40% in equity and 60% in debt. thus risk appetite, time horizon, and your goals become very important for bifurcation but 100 – age rule tells you in a very simple manner on how much you should allocate in Equity and Debt of your total investment portfolio.
let’s talk about the third rule which explains you about the personal finance very simply . A lot of people say that they do get money, salary but the biggest question is on how to utilize them on how much to invest, how much to spend on basic needs. This rule tells you all about personal finance. This rule’s name is the 50-30-20 rule. This rule tells you how to manage your personal finance.
Now take this example, say your salary is Rs 100, after paying all the taxes you receive Rs 100 .Deduct the tax from your salary and only consider your in-hand salary. Say if you have Rs 100 in form of your paid check salary after every month. How much should you spend here?
there are two types of expenses. First is basic expenses also called necessity which can’t be ignored
like house rent, grocery and many other basic expenses which can’t be ignored and you will have to spend . so out of your Rs 100 salary, you should keep Rs 50 for basic needs like rent, groceries, petrol for commute . try to maintain your basic expenses in Rs 50 and should not go beyond it.
lets talk about wants. What are these wants?
After basic activities, there are certain activities which cannot be ignored in our personal life. the expenses which can be avoided but we don’t avoid them as it is according to our standard of living in order to avoid them, we might have to face inconvenience, an activity which can be avoided with a bit of inconvenience is considered to be in wants. Your wants can be your move tickets, trip expenses, shopping. These arent your basic necessity but you need. and with a bit of inconvenience you can leave them. out of total salary, 50% you took out for basic needs after which 30% you may spend on your wants.
Now the rest 20% is very important for any common man on what he does with that 20%. the mistake with many people do is spending the left 20% on wants cause of which they cant do investment. This rule clearly states 50% is spent on needs, 30% on wants. Now the 20% must go on savings & investments. Now two things come out in savings & investments, first savings where you should have your emergency fund . so that in a state of emergency you have some money to spare thus you should allocate a part of 20%. the money left should be completely used for investment.
Now how to invest should be on the basis of the previous two rules which I explained . You can use 100 – age rule and bifurcate your money and the 72/return can tell you in how many years you can double your investment . so you can see how integrated these 3 rules are, this can help you to save and manage your personal finance . Many people might have this question, that I have a loan and where does this loan fall under the 50-30-20 rule.