ULIPs and mutual funds are two popular yet distinct investment avenues, each coming with its unique set of benefits and drawbacks. Know which one is better for your individual needs and preferences.
As the investor Warren Buffet once wisely observed, "Do not save what is left after spending; instead, spend what is left after saving."
While there seems to be a thumb rule for everything in life — from avoiding clichés in writing to starting with a powerful serve in tennis — the realm of investing shouldn't be any different. Investing, after all, is more than just about numbers and charts; it's a strategic game where each move can either propel your wealth or diminish its value drastically.
In this write-up, we will demystify the often overwhelming world of finance with 7 thumb rules for investing. These tried-and-tested principles will be helpful for both novice and seasoned investors in making decisions that are not only wise but also straightforward.
So without further ado, let's dive in and explore these golden rules.
Now that we've established the importance of thumb rules in investing, let's delve into the specifics that can help you steer your financial journey. The beauty of these principles lies in their simplicity and efficacy.
Here, we will explore four key rules - the Rules of 72, 114, and 144. Each rule serves as a distinct guide to predict how your investments will grow. These rules apply the power of compounding in an intuitive way, providing invaluable insights for your financial planning.
The Rule of 72 is a straightforward way to estimate how many years it will take for your investment to double at a fixed annual rate of return.
Imagine this: You've invested AED 100,000 expecting a return rate of 10% per year.
So when will your money double?
Just divide 72 by your anticipated return rate. As per this formula, the doubling time = 72 / 10, i.e., 7.2 years. This rule applies predominantly to investments offering compound interest.
If you aim for your investment to double in a fixed time frame like, say, 6 years, you can simply reverse the formula: Rate of Return = 72 / 6, which equals 12% per annum.
Just as the Rule of 72 helps you determine the time for your investment to double, the Rule of 114 can help you estimate when your investment will triple.
Using the same AED 100,000 investment with a 10% annual return, dividing 114 by the return rate will give us the 'Tripling Time': 114 / 10 = 11.4 years. If you have a specific time frame in mind, say 6 years, the required return rate would be as follows: 114 / 6 = 19% per annum.
Similarly, the Rule of 144 can help determine when your investment will quadruple.
With an investment of AED 100,000 and an annual return rate of 10%, the 'Quadrupling Time' is calculated as 144 / 10 = 14.4 years. This rule, like the others, also applies to compound interest investments.
To achieve a quadrupling in 6 years, the required return rate would be this: 144 / 6 = 24% per annum.
Having covered the rules to understand the growth of money, let’s also understand how inflation would impact your wealth creation with the Rule of 70.
This rule helps you understand the impact of inflation on your current wealth over time.
If you consider a sum of AED 500,000 and an inflation rate of 5%, the rule of 70 can help calculate when your money will be worth half of its current value. The formula is simple: 70 / 5 = 14 years. Thus, without investment or expenditure, your AED 500,000 will hold the purchasing power of AED 250,000 in 14 years due to inflation.
We'll now explore three insightful rules to help you make the most of your wealth – The Net Worth Rule, The 100 Minus Age Rule, and The 10% for Retirement Rule. Each rule offers a unique perspective on wealth assessment, asset allocation, and retirement planning, respectively.
To gauge your wealth status, an oft-used straightforward mathematical equation is this: your age multiplied by your gross income, divided by 10. If your net worth meets or exceeds this figure, you're considered wealthy.
For instance, if you're 30 years old with an annual income of AED 120,000, your net worth should be at least AED 360,000 to be regarded as wealthy. This approach was popularised by Thomas J. Stanley and William D. Danko in their book The Millionaire Next Door as a measure of wealth among self-made millionaires.
This rule serves as a practical guideline for asset allocation, determining how much of your portfolio should be in equities versus debt. By subtracting your age from 100, you can find the percentage of your investments that should ideally be placed in equities, with the remainder allocated to debt.
For instance, if you're 25 years old and planning to invest AED 10,000 per month, 75% (or AED 7,500) should be invested in equities, with the remaining 25% (or AED 2,500) allocated to debt. As you age, your allocation to equities decreases and your debt allocation increases as per this rule.
When it comes to retirement savings, it's never too early to start. Even if retirement seems distant, saving a small percentage from the outset can lead to a significant corpus over time. Ideally, 10% of your salary should be set aside for retirement, increasing by an additional 10% each year.
For example, suppose you're 25 years old and earn AED 30,000 per month. By investing 10% (or AED 3,000) every month and increasing this by 10% annually, you'd accumulate a corpus of approximately AED 34 million by the age of 60, assuming a 10% return on investment. This is a simple yet powerful strategy to ensure a comfortable retirement.
In the realm of financial planning, the path towards prosperity can seem convoluted, particularly to those new to investing. Yet, as we have explored throughout this article, a few straightforward rules of thumb can help you.
All these principles, whether pertaining to understanding your net worth, deciding the right asset allocation, or planning for your retirement, serve to simplify and demystify the intricacies of financial management.
Embracing these rules is akin to equipping yourself with a strategic map, allowing you to navigate your wealth-building journey with greater confidence. Always remember, investing isn't merely a numbers game but a lifelong strategy to secure and grow your wealth.
Keep learning, keep investing, and watch your wealth grow!