The world of finance can be complex and overwhelming, especially for new investors. In an effort to simplify things, financial experts often provide “rules of thumb” for people to follow. These rules can be helpful in getting started and establishing a basic understanding of how to manage your money.
However, as investors become more experienced and their financial situations evolve, they must be willing to bend or even break these rules to make the most of their money. Going beyond the rules of thumb can help set your finances in order and allow you to take advantage of opportunities that may not be available if you stick strictly to the basics.
It’s important to continue learning and growing in your financial knowledge to make informed decisions that align with your unique financial goals and circumstances.
Here are 4 that you must break rules in 2023
1. Invest And Forget
When it comes to investing, there are a variety of different strategies that people can use to try to maximize their returns. One common approach is to “invest and forget.”
This approach involves buying stocks and holding onto them for a long period of time, without making any changes or adjustments to the portfolio. This approach can be appealing for a number of reasons, as it avoids the stress and uncertainty of trying to time the market, which can be a difficult and unpredictable task.
However, while “invest and forget” can be a good approach for some investors, it’s important to remember that it’s not a set-it-and-forget-it strategy. It’s crucial to periodically review your portfolio and make adjustments to ensure that you’re still on track towards your financial goals.
One important reason for this is the risk of unrealized gains, where you have gains on paper but haven’t yet converted them into real profits.
For example, consider the case of the Nasdaq, which is a popular stock market index that tracks the performance of technology stocks. In March 2000, the Nasdaq reached a high of 5,048, but it then experienced a sharp decline and took 15 years to cross the 5,048 mark again in April 2015.
If you had invested in the Nasdaq at its peak in 2000 and held onto it without making any changes, you would have had unrealized loss on paper for over a decade.
To avoid this risk, it’s important to periodically review your portfolio and make adjustments as needed. One important step is to define your asset allocation, which means deciding how much of your portfolio should be invested in different types of assets, such as stocks, bonds, and cash.
Once you have a target asset allocation, you should periodically review your portfolio to make sure that it still aligns with your goals. If your investments become too skewed towards a particular asset, you may need to rebalance your portfolio by selling some assets and buying others.
By periodically reviewing your portfolio and making adjustments as needed, you can ensure that you’re making the most of your investments and avoiding the risk of unrealised gains or loss.
While “invest and forget” can be a good strategy for some investors, it’s important to remember that you still need to stay engaged and make adjustments as needed to ensure that your portfolio stays aligned with your goals.
2. Asset Allocation Based On Age
Asset allocation is a critical aspect of investing that determines how your portfolio is divided among different types of assets, such as stocks, bonds, and cash. One common rule of thumb for determining asset allocation is to subtract your age from 100, which gives you the percentage of your portfolio that you should invest in equities, with the remainder in debt. For example, a 35-year-old would invest 65% in equities and 35% in debt
However, this rule of thumb is far from perfect, and there are many factors that need to be considered to determine the right asset allocation for your unique situation. Every investor is different and has a different risk profile, which should be taken into account when determining asset allocation.
In addition to your age, there are two key factors that should be considered when determining asset allocation: time horizon and risk profile.
Time horizon refers to the length of time you have to reach your investment goals, such as retirement or buying a house. If you have a longer time horizon, you may be able to take on more risk in your portfolio, whereas if you have a shorter time horizon, you may need to be more conservative.
Risk profile refers to your personal tolerance for risk, which can vary greatly from person to person. Some investors may be comfortable taking on more risk in exchange for potentially higher returns, while others may prefer a more conservative approach that prioritizes capital preservation over growth.
Ultimately, the best approach to determining asset allocation is to work with a financial advisor who can help you assess your goals, risk profile, and time horizon to develop a customized plan that meets your unique needs. While the age-based rule of thumb can be a starting point, it’s important to remember that every investor is different, and asset allocation should be tailored to your specific situation.
3. Higher The Risk, Higher The Returns
The idea that “higher the risk, higher the returns” is a common misconception in investing. While it’s true that some investments may offer potentially higher returns, it’s important to understand that higher risk does not always translate to higher returns.
For example, some investment products, such as small-cap funds, may take on higher risks but don’t necessarily offer higher returns. Small-cap funds invest in companies with smaller market
capitalizations and are often more volatile than the broader market. While these funds may have the potential for higher returns, they also carry higher risks and can experience significant losses during market downturns.
In addition, there are many other factors that can affect investment returns, such as economic conditions, company performance, and interest rates, to name a few. It’s important for investors to conduct thorough research and analysis before investing in any product, and to carefully consider their risk tolerance and investment objectives.
Ultimately, the key to successful investing is to have a well-diversified portfolio that is tailored to your individual needs and risk profile. This may include a mix of investments with varying levels of risk and return potential, as well as regular monitoring and adjustment as needed to stay on track towards your goals.
4. Term Plan Cover = 10X Your Annual Income
Insurance is an important aspect of financial planning and securing one’s future. While selecting a term plan cover, it is essential to calculate the insurance cover needed accurately. One common method is to take a term plan cover equal to ten times your annual income.
However, there are two better ways to calculate the insurance cover you need. The first method is the Income Replacement Value, which involves multiplying your annual income by the number of years left for retirement. For instance, if your annual income is Rs. 12 lakh, and the years left for retirement are 25, your cover should be Rs. 3 crore (12,00,000 × 25).
The second method is Human Life Value (HLV), which uses a complicated formula considering factors like age, income, savings, loans, and the potential earnings of the future. Though complicated, you can easily find HLV calculators online to determine your cover more accurately. Ultimately, it is essential to choose a term plan cover that ensures the financial security of your loved ones.
