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| Capitalstars Investment Advisor |
Never take a loan to invest. Don’t borrow more than you can repay. Spend less than you earn. It is often said that if you stick to these simple rules, you won’t ever go wrong in money matters. In financial planning too, there are several thumb rules that serve as broad guidelines for formulating strategies.
Financial planners believe that significant changes in the past few years have rendered some time-tested tenets obsolete. While these canons of financial planning are still very useful, they need to be updated and aligned with the new realities.
For instance, a 25-year old may need a life insurance cover of more than the recommended 10 times his annual income. In the following pages, we look at some of the rules that need to be tweaked given the new financial landscape and explain the reasons for the change. We hope readers will find it worthwhile to implement these changes in their financial planning.
1. Rule to junk: Save 10% of your salary for retirement
Rule to follow: Increase the savings rate to 20%
There was a time when 10% of your monthly income was enough to create a corpus for sustaining a comfortable retirement. But those days of low inflation and defined pension are gone. If you stick to the 10% rule, your retirement corpus may not be enough to cover rising lifestyle and medical inflation. “Considering the higher life expectancy rates, you should save at least 20% of your income for retirement,” says Pankaj Mathpal, Founder, Optima Money Managers.
Mumbai-based Beezan Charna, 35, is convinced that increasing cost of living necessitates higher savings for retirement. “Given the rising lifestyle and healthcare inflation, I have been investing 20% of my take-home salary in equity funds solely for retirement. It is better to save more now than repent later,” he says.
2. Rule to junk: Equity exposure should follow the 100 minus age formula
Rule to follow: Equity exposure should be 110-120 minus age
Financial planners argue that the 100-minus your age rule no longer holds true as lifespans are much longer now. Instead of 15-20 years in retirement, people must save to sustain 20-25 years of retired life. This, in turn, means that the equity allocation must be higher across ages, particularly for younger individuals, provided one has the risk appetite.
3. Rule to junk: The 50-20-30 budgeting rule for necessities, savings and wants
Rule to follow: Save at least 30% of your income every month
The 50-20-30 rule recommends an allocation of 50% of your post-tax monthly income towards basic needs, 20% towards goal-oriented investments and the balance 30% towards your discretionary expenses.
However, financial planners recommend increasing the savings figure to 30% or even 40% if you are not servicing loan EMIs. “Attractive salaries drawn by corporate employees these days allow for a higher allocation towards savings. Today, it is more important than ever to save for your future goals, given the lifestyle inflation,” notes Mathpal.
4. Rule to junk: Contingency fund should be equal to 3-6 months’ expenses
Rule to follow: Corpus should cover nine months’ expenses
A contingency fund is meant to cushion the impact of any financial or medical emergency. Setting aside funds worth 3-6 months’ of your household expenses in a liquid fund or a fixed deposit is usually the first step towards building an emergency corpus. However, the quantum may need a relook, say financial planners. Gandhi recommends a contingency fund that can take care of your expenses for nine months.
Besides a job loss, a medical or a financial crisis, you can use it as a cushion to meet other unforeseen crises and short-term needs. “It is not rare to see people switching careers, taking a mid-term break or studying further to sharpen their job skills these days. In the interim, a bigger contingency corpus will prove to be useful,” she says.
5. Rule to junk: Life insurance cover should be 10 times your annual income
Rule to follow: Hike cover to 15-20 times your annual income if you are under 40
An insurance cover of 10 times your annual income seems quite sufficient for the average person. But not when you have just started your career and income is low. At that age, the life insurance cover should be much higher. “Insurance cover should be 20 times the annual income if you are buying at a younger age because your income tends to rise faster in the initial years and you cannot increase your life cover every year,” says Mathpal
6. Rule to junk: A health cover of Rs 3-5-lakh is adequate for metro dwellers
Rule to follow: Look at a total health cover of at least Rs 10 lakh
Advancements in the field of medicine are curing many life-threatening illnesses, but have also pushed up costs. Healthcare inflation in India is estimated to be around 15%. A Rs 3 lakh or a Rs 5-lakh cover is no longer sufficient for a family-based in a metro. “I realized that a Rs 3 lakh cover is grossly inadequate mother underwent surgery last year,” says Jay Shah, who is employed with a real estate major in Mumbai. The incident convinced him to enhance his family’s health cover. “If you try to buy a large cover later, you may have to pay an exorbitant premium,” he explains. He now has a Rs 25-lakh family floater health policy that covers his wife and kids.