A thumb rule is a guideline that provides simplified advice regarding a particular subject. This article will touch upon different thumb rules that should be followed while investing. There are different kinds of investments. Secure Vs Risky investments. Long Term Vs Short Term investments etc. 

1) Thumb rule for risk management or asset allocation – 100 minus your age rule

Traditional knowledge is that those who are young can take more risks in their investments in order to earn better returns. Those who are middle aged or old aged should take only moderate or low risks in their investments. The thumb rule for making risky investments in stock markets or mutual funds is 100 minus your age. For example, if a person’s age is 70, he can a make a maximum of only 30% (i.e., 100 – 70) of his total funds in risky investments like stock markets or mutual funds.

2) Thumb rule for liquid investments or emergency fund

Generally speaking, long term investments give better returns than short term or liquid investments. But long term investments (examples are PPF, NPS, NSC, Government bonds etc) are locked in for a longer period of time and can not be withdrawn when one needs money or when there is an emergency. The thumb rule in this regard is that one should keep 6 months of their expenses in liquid investments like bank accounts or liquid mutual funds towards emergency fund.

3) Thumb rule regarding safety of investments – Avoid Ponzi schemes

Nowadays, many people are falling prey to promises of hefty returns made by fraudsters and in the process, they lose their hard earned savings in questionable investments made in bogus investment schemes. Let’s face it – there’s no easy money. The thumb rule to ensure safety of your investment is – avoid all Ponzi schemes (which promise impossible returns like 200% or 300% of your investment in one year) or pyramid schemes/ multi-level marketing schemes (which promise high returns provided you bring in additional 5 new investors and such new investors again rope in further new investors) or weird schemes like plantation companies.  

A Ponzi scheme is a scheme in which investors are paid from money collected from new investors instead of the scheme’s earnings. It works as long as new investors keep coming in. 

4) Thumb rule for home purchase

A home purchase should cost less than an amount equal to two and half years of your annual income. If the investment in home purchase is far in excess of this thumb rule, you may be purchasing a white elephant which is beyond your means.

5) Thumb rule for life insurance coverage

The thumb rule for for life insurance coverage is that the death benefit on your policy should equal to 10 times the amount of your annual salary, in order to take care of your dependents comfortably in your absence.

6) Thumb rule for saving

As a thumb rule, 10% of post-tax income should be saved by those who are just starting their career at an age of 25 or so. As you grow older, your income rises and also financial liabilities add up. Hence in middle age, saving should be at least 35% of your post-tax income.

7) Thumb rules for stock market investments   

• Be fearful when others are greedy. Be greedy when others are fearful.
• It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price (Warren Buffet).
• Rome wasn’t build in a day but Hiroshima/Nagasaki were destroyed in a day. ( It means, you can’t become rich overnight, but your whole life time’s savings can be destroyed due to your greedy behavior.)
• Stock market represents investors sentiment in the short term and company fundamentals in the long term.
• Buy stocks you would want to hold if the market were to close for 10 years.