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The Golden Thumb Rules of Personal Finance you need to know!
Investing Made Simple: Beginner's Guide to Financial Growth
Managing personal finances is not just about budgeting and saving; it’s a holistic approach to creating a healthier financial life, freedom, and resilience in the face of life’s uncertainties.
It directly impacts an individual’s present and future well-being. However, in the vast arena of financial planning, one often feels overwhelmed.
Almost everyone knows the importance of budgeting, saving, and investing, but how to begin this journey is still a daunting question for many.
Also, we live in an era where we are constantly exposed the materialistic pleasures and are subconsciously provoked to indulge in them.
Many times this leaves our finances in the doldrums.
So, should we not indulge and enjoy?
Yes, we should! But bearing in mind certain personal finance rules will surely stop you from going overboard and putting you in shaky financial spots.
Why Thumb Rules in Personal Finance
We all crave shortcuts in life, which is perhaps why “thumb rules” hold a certain appeal.
Personal finance / financial planning thumb rules are simplified guidelines for managing money with basic principles, but their one-size-fits-all approach falls short.
These simplified principles offer a quick starting point for planning your finances. However, no two individuals have identical needs or circumstances and therefore they need to be modified and adapted.
Also, while they can provide a starting point, relying solely on them for crucial financial decisions can be hazardous.
As the editor of The Journal of Financial Planning aptly stated, “Financial rules of thumb are for people who want to decide things without thinking about them.”
Dismissing them entirely, however, would be a disservice. When used thoughtfully and in conjunction with personalized analysis, these shortcuts can be a prompt hand-holding in the financial planning journey.
Let us learn some Thumb Rules of Personal Finance from Steve
Meet Steve – a regular guy with an extraordinary approach to personal finance.
Steve’s journey from financial uncertainty to stability is a testament to the power of strategic money management.
Steve wasn’t born with a silver spoon, but he sure now knows how to polish his budget like a pro.
While his friends chase the latest trends and struggle to make ends meet, Steve sails through life financially secure and stress-free.
How? It’s all thanks to his finance thumb rules, simple principles that guide his every spending decision.
Rule #1: Needs First, Wants Later:
Steve prioritizes like a champion. Rent, groceries, bills – they’re treated like non-negotiables.
He allocates a fixed percentage of his income to these essentials, ensuring his basic needs are always covered.
This leaves him free to enjoy his “latte money” without guilt, knowing his financial foundation is rock solid.
Rule #2: The 50/30/20 Mantra:
Steve swears by the 50/30/20 rule. 50% of his income goes towards his needs, 30% fuels his passions (concerts, gadgets, weekend trips), and 20% gets stashed away for savings and investments.
Remember we spoke about indulging in life’s pleasures? So we can indulge. This mantra prioritizes and keeps expenses on track.
Rule #3: The Emergency Fund: Steve's Financial Lifeboat:
Having weathered unexpected financial storms in the past, Steve emphasizes the importance of having a robust emergency fund.
His rule is to set aside at least six months’ worth of living expenses.
This financial lifeboat has rescued him from the choppy waters of unforeseen circumstances more than once.
Example: With $2,500 in monthly expenses, Steve maintains a $15,000 emergency fund, providing peace of mind during uncertain times.
Rule #4: The Power of Automation:
Steve uses a lot of technology, especially when it comes to finances. He automates as much as possible.
Bills get paid automatically, a set amount gets transferred to savings every paycheck, and even his investments are on autopilot.
This saves him time, reduces stress, and ensures he stays on track, even without him executing it.
The biggest benefit of the autopilot is that your needs and savings are addressed effectively and you are left only with a chunk of your money.
This way you will never overspend on unwanted aspects.
Rule #5: Track Like a Pro:
Steve knows where his money goes. He uses budgeting apps and spreadsheets to track every expense, from groceries to gym memberships.
This awareness empowers him to make informed choices, identify unnecessary spending, and adjust his monthly budget when needed.
Rule #6: Treat Debt Like Kryptonite:
Steve views debt with a healthy dose of suspicion. He avoids spontaneous and impulsive credit card purchases and pays off existing debt on priority, sometimes even forepays it.
He knows the power of compounding interest and refuses to let debt drag him down.
Rule #7: Invest in Yourself:
Steve understands that the best investment he can make is in himself. He takes courses, attends workshops, and reads books to constantly improve his skills and knowledge.
This not only enhances his earning potential but also opens doors to new opportunities.
Rule #8: Live Below Your Means:
Steve doesn’t chase a fancy lifestyle. He values experiences over possessions and prioritizes quality over quantity.
He’s happy with used cars, rented apartments, and home-cooked meals.
This frugality allows him to save more, invest more, and ultimately, live a life free from financial constraints.
Importance of Managing Personal Finances
Managing personal finances is of paramount importance for several reasons. It directly impacts an individual’s present and future well-being.
Without appropriate management of one’s income and expenses, irrespective of the earnings one is bound to face difficulties eventually.
Here are some major reasons why managing Personal finance should be everyone’s priority.
- Financial Stability: Effective management ensures a stable financial foundation with a sense of security. It allows individuals to meet their basic needs, pay bills, and handle unexpected expenses. It helps you stand tall in unforeseen circumstances that demand expenditure or even loss of income due to circumstances.
- Goal Achievement: Personal finance management enables individuals to set and achieve financial goals. Whether it’s saving to buy a home, for education, to travel, or for retirement, having a well-thought-out financial plan helps you achieve your long and short-term goals hassle-free.
- Debt Avoidance or Reduction: Proper financial management helps individuals avoid accumulating excessive debt and helps in the reduction of existing debts. This puts in him better financial equations and stops him from getting dragged into the debt trap.
- Emergency Preparedness: Building an emergency fund is a key component of personal finance management. This fund acts as a financial safety net, providing resources during unexpected events such as medical emergencies, job loss, or unforeseen expenses. It is advisable to hold 3 to 6 times your monthly income in your emergency fund pocket.
- Wealth Building: Through strategic investing and saving, effective personal finance management contributes to wealth accumulation. Your passive money also works for you to build wealth. When made wisely, investments can grow over time, allowing individuals to build financial wealth and secure their future.
- Retirement Planning: Managing personal finances includes preparing for retirement. Regular contributions towards building a retirement corpus ensure financial security during the post-working years, maintaining a comfortable standard of living. Aim to build your retirement corpus 20 times your annual income. This is keeping in mind you retire at 60 and live till 80 years of age.
- Financial Freedom: Right financial management paves the way for financial freedom. It allows individuals to make choices based on preferences rather than financial constraints, providing a higher quality of life and greater overall satisfaction.
- Adaptability to Life Changes: Life is unpredictable, and effective personal finance management provides the flexibility to adapt to changing circumstances. Whether it’s starting a family, buying a home, or changing careers, a solid financial plan facilitates smooth transitions.
Rule of 72 and 70 for Financial Planning
The Rule of 72 states that you can approximate the number of years it takes for an investment to double by dividing 72 by the annual rate of return.
For example, if you have an investment with an annual return of 8%, it would take approximately 9 years for your investment to double (72 ÷ 8 = 9).
This rule offers a handy mental shortcut for investors to gauge the potential growth of their investments over time.
The Rule of 70 is a handy and common rule of thumb that helps estimate how many years it takes for inflation to erode the value of your money to half.
Simply divide 70 by the annual inflation rate. For instance, with a 7% inflation rate, 70 / 7 = 10 years. This means that in 10 years, your $ 100 note will be worth roughly $ 50.
While not a perfect calculation, the Rule of 70 offers a quick and easy way to grasp the impact of inflation on your savings and future purchasing power.
Understanding this is crucial for making informed financial decisions, such as planning for retirement or setting investment goals.
Parting Thoughts
These are just a few of the nuggets of wisdom that can be applied to a vast majority of earning individuals.
They may seem simple, but their cumulative effect is profound.
So, commit to one rule at a time, and remember, small, consistent steps lead to giant leaps toward financial freedom.
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