When we talk about rules, our minds will often leap to the regulations and laws that can trip us up.
But rules can also come in the form of guidelines and processes that can make our lives much easier. A good example are the investment-based rules of thumb that we can use to help us plan, make and track progress. They may be approximate, but that’s usually good enough and it allows us to see where our perception is well wide of the mark. Here are ten rules of thumb to help us reach our goals.
The sixty-something rule
This rule indicates the age at which you aim to have enough money to stop working. To work out what age that would be for you, start with your savings rate, which is the difference between what you earn after tax and what you spend as a percentage. This is then subtracted from 60. Say you earn £30,000 and manage to save £6000 a year, then your savings rate is (6,000 ÷ 30,000) x 100 = 20%. Then take the 20 away from 60 and you’ll have to work for 40 years. If you manage to save another £300 a year, then that brings the rate to 21% and you can stop work a year earlier. This rule starts to break down when the savings rate gets unrealistically high — around 40% — and it ignores windfalls (or unexpected costs).
Win it, then one it
Somebody has to win the lottery but you’re more likely to receive a bonus or an inheritance. If you happen to have been particularly jammy, use 1% of your windfall to indulge yourself now. Then put the rest somewhere you won’t be tempted to dip into and leave it there for six months. A high-interest notice account might be best. Six months on, did you miss the money? Or maybe you still want to buy that new car? Either way, you gave yourself time to research a purchase and won’t experience buyer’s remorse.
The 72 rule to double your money
This tells you how long it will take for your money to double. Divide 72 by the interest rate or rate of return you are using or earning, and it gives you the number of years it will take for your money to double in value. Say the rate of return is 6%, then your money will double in 12 years (72÷6=12). Mathematically it should really be 69.3, but 72 is good enough and much easier to remember.
The 144 rule
As the name suggests, this is a variation on the 72 rule and helps you calculate how many years it will take for your money to quadruple with a fixed return or interest rate. It can be particularly helpful for retirement planning and it has the same formula as the 72 rule: you divide 144 by the interest rate or rate of return you’re earning to arrive at the number of years in which the money will grow four times.
Three-month emergency fund rule
Having at least three months of emergency cash means being able to continue meeting your essential outgoings (such as bills and mortgage repayments) if your main source of income were to suddenly disappear. It’s almost universally used as a benchmark by financial planners. An emergency cash buffer of at least three months — and ideally up to six — means you can cover your costs without having to sell your investments or dip into your savings.
It doesn’t mean your current account has to hold it all. Around two to four weeks’ worth should be fine in your current account, with the rest in higher interest or notice accounts. Common sense has to prevail — a couple with children or those in a job where finding another would take time, will need more.
The 10, 5, 3 rule
This is the expected long-term return from equities, bonds and cash: 10%, 5% and 3% respectively. It hasn’t quite worked out like that in recent years, but it’s roughly how it plays out over the long term. It can be combined with the rule of 72 so we can see how long it takes for each asset class to approximately double in value.
- Equities 72÷10= 7 years
- Bonds 72÷5= 14 years
- Cash 72÷3= 24 years
If you have a target amount to achieve over twenty to forty years, you’ll see why using cash alone is probably not going to be sufficient. Equities historically offer the best long-term returns and should help you reach higher targets, but they also come with greater risk. In the 10,5,3 rule, the real returns would be reduced by inflation.
The 100 minus your age rule
This is another asset allocation rule: 100 minus your age gives you the percentage you should aim to hold in equities, with the balance going into low-risk bond assets. To use a simple example, at age 20 you might need 80% equity, 20% bonds. At age 50, you’d have 50% in each. The idea is that you move out of equities and into lower risk assets as you get older (which is what is often referred to as de-risking or life styling).
The 4% rule
This is a retirement income withdrawal rule. The theory goes that if you take no more than 4% of your portfolio as income then it will last at least 30 years. The origins of this rule are based on the returns generated by a balanced portfolio of equities and bonds.
The 4% rule has worked well for some people, but it’s now considered by many to be overly optimistic, and it should only really apply to the first year or so of retirement. These days, advisers use sophisticated cash flow models and blend income from different sources to prevent depletion.
Some people will continue to work or maybe receive windfalls so sticking to 4% may see them experience an unnecessarily frugal retirement. The downside is that those having a one-off splurge, especially early on in retirement that can ravage the portfolio where it cannot recover. It’s a bit like plants being hit by a late frost — they never recover no matter how good the summer.
The 8 to 18 fund rule
This is the manageable number of funds in your portfolio. If the number of funds is greater than 18 then it can get difficult for an investor to keep track of what is going on — professional portfolio managers tend to run at about 50 fund holdings but are on the case 24/7 and have a supporting team. Another problem with holding too many funds is that overlap can occur.
Funds may well hold the same underlying investments, meaning your portfolio can become overly reliant on a small number of large stocks without you realising. The portfolio can also mutate into an unwieldy collection of mismatched funds. Having too many funds can make you well diversified but at a high cost —you may as well have a cheap mixed asset fund or trackers.
Have a good look at your portfolio and give it a spring clean by switching out of the poor performers. Bestinvest’s regular Spot the dog report can help with this, but most platforms have fund performance tools you can use.
Alternatively, if you don’t have time to manage your own portfolio, then it’s worth considering a risk-managed multi-asset fund or having an adviser do it all for you. Try our easy-to-use platform comparison tool, one of our three free comparison tools.
The thirty-minute rule
Now when did you last check your portfolio? I mean properly. Here is a good rule to try: think of your intended retirement age, double it, add sixty, divide the answer in half, and subtract the number you initially thought of. The answer is thirty, which is the number of minutes needed to check your portfolio.
All the above rules are simple shortcuts that can help you navigate your way through the maze of saving and investing. They’re tried and tested and widely used, but make sure you do your own research. Our free comparison tools are a good place to start if you want to make sure you’re getting the best out of your investments.
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