The 12 most popular investing rules & frameworks
Managing personal finances can be overwhelming, especially for those who do not have a solid financial background.
However, some basic investing rules and principles can serve as a solid foundation for making informed decisions about saving, investing, and spending money.
The twelve investing rules presented in this blog post provide a helpful framework for managing finances and cover a range of topics, from building an investment strategy to asset allocation and risk management.
By following these rules, you can make more informed financial decisions and work toward achieving your long-term financial goals.
While everyone’s financial situation is unique, understanding and applying these investing rules can provide a solid foundation for financial stability and success.
1. The 4 % rule
The 4% rule is a popular rule of thumb for retirement planning. It says you can withdraw 4% of your investment portfolio each year (adjusted for inflation) and have a high probability of not running out of money in retirement.
This rule is based on historical market data showing that a 4% withdrawal rate would have provided sufficient income for at least 30 years in most cases.
There are two ways to apply this rule:
- Multiply your desired annual withdrawal by 25: This is how big your portfolio must be.
- Multiply your total portfolio by 4 %: This is your maximum annual withdrawal amount.
However, the 4% rule is not a guarantee and there are many factors that can affect the success of this strategy, such as the timing (retiring in a downturn can be tricky) and sequence of market returns, inflation, and fees.
Nevertheless, it’s a good general guidance.
2. The rule of 72
The Rule of 72 is a quick and easy way to estimate how long it will take for your investments to double in value. This rule works by dividing 72 by your expected rate of return.
For example, if you expect an 8 % annual return, it will take approximately 9 years for your investment to double (72/8=9). If you invest 100.000 EUR at 8 % annual return, you will have 200.000 EUR in 9 years.
The rule of 72 can also be used to determine the rate of return required to double your investment in a given number of years. For example, if you want to double your investment in 10 years, you need an annual return of 7.2 % (72/10=7.2).
3. The rule of 144
The Rule of 144 is another variation of the Rule of 72 and is used to estimate how long it will take for the value of your investment to quadruple. To apply this rule, divide 144 by your expected rate of return.
For example, if you expect an annual return of 8 %, it will take approximately 18 years for your investment to quadruple (144/8=18). It would take 18 years for your 100.000 EUR to turn into 400.000 EUR at 8 % annual return.
4. The Your age rule for bond/stock allocation
The traditional rule of thumb for determining how much you should invest in bonds is to use your age as a percentage of your portfolio in bonds.
For example, if you are 30 years old, you should invest 30 % of your portfolio in bonds. However, this may be too conservative for some investors.
A more aggressive approach would be to subtract your age from 120 and invest that percentage in stocks and the remaining percentage in bonds. For example, a 30-year-old would invest 90 % in stocks (120 – 30 = 90) and 10 % in bonds.
5. The 5/25 rule
The 5/25 rule is a simple way to determine when you should rebalance your portfolio. According to this rule, you should rebalance your portfolio when an asset class grows or shrinks by more than 5 % of the portfolio’s value.
For example, if a stock makes up 25 % of your portfolio and increases to 30 % or decreases to 20 %, you need to sell or buy more shares. Also, if small asset classes (e.g. individual stocks) increase or decrease by 25 % of their value, it is time to rebalance.
6. The 7-year rule or The 5-year rule for more aggressive investors
The 7-year rule advises against investing money you expect to need in the next 7 years if you want to be conservative. Those who want to be more aggressive should not invest money they will need in the next 5 years.
Since stocks can be volatile, investing money you need in the short term could put your portfolio at risk. By avoiding this, you can ensure that your money retains its value.
7. The 5 % rule
The 5 % rule states that no more than 5 % of your portfolio should be invested in any one stock. It is risky to tie your assets to a single company. By limiting each company to 5 % of your portfolio, you can hedge against this risk.
8. The 10/5/3 rule
The 10/5/3 rule is a general guideline for long-term average annual returns for various types of investments. Stocks have historically returned an average of 10 %, bonds have averaged 5 %, and other cash investments such as CDs and high-yield savings accounts have averaged 3 %.
- 10 %: Stocks
- 5 %: Bonds
- 3 %: Deposits
However, it is important to note that these averages may not apply in the short term and should not be taken as a guarantee of future returns.
9. The Buffett rule
It’s a simple rule that says invest in what you know. This Buffer rule emphasizes the importance of investing in companies or industries that you are familiar with and understand.
By doing so, you as an investor can make more informed investment decisions and avoid potentially costly mistakes.
10. The Golden rule of investing
The Golden rule of investing says buy low and sell high. This rule encourages investors to buy assets when they are undervalued and sell them when they are overvalued.
This rule can be difficult to follow because it requires discipline, emotional regulation and a long-term perspective. But since it is the golden rule of investing it’s absolutely a rule worth practicing to follow.
11. The Rule of 20
The Rule of 20 says that the sum of the current price-to-earnings ratio (P/E) and the inflation rate should not exceed 20.
This rule provides a simple framework for assessing whether the stock market is overvalued or undervalued.
12. The All-Weather Portfolio
This rule emphasizes the importance of diversification. It states that investors should hold a mix of assets that can perform well in different economic environments, including stocks, bonds, commodities and cash.
In other words, you should build a solid investment strategy and then adjust it to changes in the macroeconomic environment.
Which of these investing rules you like the most?
These investing rules can help you as an investor to make more informed decisions about your financial future and work toward achieving your long-term financial goals. Go through the rules and choose the ones you would like to follow.
Think of these rules as a general guide and take them with a grain of salt. Nonetheless, they can definitely be helpful when it comes to forging a solid investment strategy.