Pay Yourself. The Importance of Monthly Contributions While Investing
Pay Yourself. The Importance of Monthly...
4 February 2022

Pay Yourself. The Importance of Monthly Contributions While Investing

In the early stages of financial planning, a few simple guidelines can be helpful. There is a wealth of information available to those who are just getting started in their careers. If you are in the middle of your career and don’t have a proper plan in place, thumb rules can be beneficial.. As a cautionary note, keep in mind they are just broad guidelines and may not convey the full picture.

The first and most important rule of personal finance is: ‘Pay yourself first.’ Simply put, it means that a particular percentage of your monthly money must be set aside before it can be spent on other things. ‘Income less savings equals expenses’ should be the rule, not the other way around. To ensure that this occurs effectively, first set your objectives, then estimate the inflation-adjusted requirement, and last determine how much money you will need to save to achieve them. Now, make sure that funds are transferred from your salary to your goals on a monthly basis, and manage your household costs with the money that is left over. You are, in a sense, paying for yourself first, i.e., for your objectives.

How much money do you want to save?

A general rule of thumb is that those who begin their professional careers at approximately the age of 25 should set aside 10% of their after-tax earnings as a starting point. Building a 15 percent cushion into your salary over time will provide you with a significant head start and financial security. Consider increasing your savings to meet your goals as you get older, as your income increases and financial obligations mount. Saving at least 35 percent of your after-tax income should be the goal in middle age, because expenses tend to rise during this time period, according to experts.

The Rule of 50-20-30

Having trouble figuring out how much to save and how much to spend each month? Here’s what you need to know to get started. It’s known as the 50-20-30 Rule, which states that 50 percent of your income should be allocated to living expenses, such as household expenses and groceries; 20 percent should be allocated to savings for short-, medium-, and long-term goals; and 30 percent should be allocated to spending, such as outings, food, and travel. The concept is to make outflow buckets in order to better manage the flow. According to their age, circumstances, and other factors, individuals can adjust the percentage.

The Rule of 20/4/10

When you’re in the market for a new vehicle, follow this tip to keep your spending in check. Twenty is the down payment amount, which is 20% of the car’s total price. The more money you put down, the better, so put as much as you can. The term of the loan is four years. In spite of the fact that lenders can hold a loan for up to seven years, it’s best to keep it for no more than four. Ten percent of your net take-home pay should be used to pay down your auto loan EMIs.

Fund for emergencies

An emergency, as the name implies, can occur at any time and necessitates rapid action on the part of the responder. The possibility of suffering a temporary disability or being out of work for a few months could result in a reduction in one’s earning capability. A medical emergency may arise at a time when the settlement claim is taking longer than expected, or the illness itself may require a waiting period before it can be treated. In such instances, it may be necessary to plan for financial assistance to get through the crisis. No matter if it’s paying for household bills or keeping up with EMI payments, some obligations must be met. Although there is no hard and fast rule for how much emergency funds one would require, it is recommended that one have an emergency fund equal to 3-6 months’ worth of household costs on hand. The sum should be sufficient to assist you in dealing with financial difficulties.

Coverage for life

Ideally, you should have a life insurance policy with a face value equal to at least ten times your yearly salary. It is possible that the real requirement will differ depending on one’s age, goals to be attained, financial dependents, collected money, and other factors. When it comes to acquiring life insurance, a pure term insurance plan is the most cost-effective alternative. Essentially, it is a low-cost, high-coverage protection plan in which the premium is entirely dedicated to risk coverage, i.e., to paying for the risk of death. If one survives the term, there is no money refunded to them because there is no savings component of the premium. However, this should not stop someone from purchasing a term plan as risk protection through life insurance, since it is one of the most fundamental requirements in one’s entire financial strategy.

How much should you save for retirement?

The majority of financial planners recommend aiming for a retirement corpus that is approximately 20 times one’s annual income. Some believe that 30 times can be a more appropriate ratio because it will account for inflation. In this case, you have a good reason to work backwards and estimate how much money you’ll need to save from now until retirement.

Despite this, you may be dissatisfied with this guideline because it just takes into account revenue rather than expenses. Additionally, it may be more effective for individuals who are years away from retirement rather than those who are retiring soon.

The cost of a house

It is possible to determine the value of a property that one can afford to buy by taking three factors into account: take-home income, down payment amount, and interest rate on a home loan, among others. If one is purchasing a home with a down payment of 20% and the remainder through a home loan, and also taking into consideration the income-to-EMI ratio, the affordability comes out to approximately 4.5 to 5 times one’s annual salary. In other words, one is purchasing a house that will cost about.

Obtaining a home loan

Prior to making a loan, the lender investigates the borrower’s previous loan obligations and obligations. Banks will not lend an amount on which the monthly instalments will be more than 45-50 percent of the borrower’s take-home income. This includes any other existing EMIs, such as those on auto or personal loans, as well. But what happens if the present loan is about to be paid off? “Loans with only 12 or less EMIs outstanding are not taken into consideration when determining loan eligibility, resulting in increased loan eligibility. It is recommended that the income-to-EMI ratio be near to 50 percent and not greater; otherwise, a smaller loan amount will be approved, which may cause disruptions in your household financial flow.

Furthermore, having a high credit score may not always be sufficient for obtaining a loan with favourable terms and circumstances.

How much money should you put into stocks?

With regard to investing in stocks, it is frequently stated that one must use the ‘100 minus the age’ approach to success. As a result, for a 30-year-old, 70 percent of his investible surplus should be in stocks, with the remaining 30 percent in debt. As one becomes older, one’s allocation to equities decreases since it is perceived to be more volatile than debt. It could be a smart place to start, but over time, your allocation into stocks will be determined by the duration of your objectives. For long-term objectives such as retirement.

Net Worth

This rule was devised by the writers of the book The Millionaire Next Door in order to arrive at the required net worth. According to them, your net worth should equal your age multiplied by your pre-tax salary divided by ten. That figure, less any money you may inherit, should represent your net worth at your current age and income. Consider your net worth as everything you own minus the debts and obligations you owe. This includes anything from jewellery and furnishings to your home equity. As far as adding your home to your net worth is concerned, there is still a lot of debate. As a result, unless you plan to downsize in the near future, it’s best to leave it out of your net worth calculation altogether.

Diversification

A common practice among investors is to have positions in as many as 30 different mutual fund schemes. In order to achieve the best possible outcome for the portfolio, it is not always necessary to diversify excessively. J.L. Evans and S.H. Archer’s study has demonstrated that the majority of the benefits of diversity may be acquired with a small number of funds, approximately ten. More funds are still beneficial, but the benefits appear to be insignificant when weighed against the difficulties of maintaining a larger portfolio.

Conclusion

When it comes to business strategy, there is no such thing as one size fits all. Individualized financial planning is necessary based on your risk profile, current circumstances, and other factors. As soon as you begin implementing the thumb rule, it is critical to periodically examine your progress and make any necessary adjustments to your plan.