Investing can often feel overwhelming, especially with countless strategies and rules to consider. One simple yet powerful framework that stands out is the 7-5-3-1 rule. This rule serves as a guideline for investors to create a balanced and goal-oriented portfolio. Let’s explore what this rule entails, its significance, and how it can be applied using a real-life case study.
Breaking down 7-5-3-1
The 7-5-3-1 rule outlines the key principles for achieving financial goals. Here’s what each number represents:
7% Annual return: This is the long-term average return that investors can aim for when investing in equity-based instruments like mutual funds, stocks, or index funds. Historically, diversified equity investments have delivered 7% (or higher) annualized returns over a long horizon.
5 Years of patience: The minimum time frame required to see significant compounding benefits from your investments. Equity markets can be volatile in the short term, but they tend to stabilize and reward patient investors over five years or more.
Focus on 3 financial priorities: Investors should focus on three major financial goals, such as retirement planning, children’s education, and wealth creation. Allocating resources effectively across these priorities ensures balanced growth.
Top up your SIP investment: Top up your SIP investment with 10% or 20% once a year. This strategy accelerates wealth creation and aligns your portfolio with inflation and growing financial goals.
Importance
Simplicity: The rule simplifies complex financial planning by offering clear and actionable steps.
Balance: It balances growth, patience, and sustainability, ensuring your investments align with long-term goals.
Focus: By emphasizing prioritized goals, it prevents financial planning from becoming scattered and inefficient.
Case study
Background: Rajesh, a 35-year-old software engineer, is married with two children. He earns ₹1,20,000 per month and aims to retire by 60 with a comfortable lifestyle. Rajesh also wants to fund his children’s higher education and purchase a house in the next 10 years. His current investments include a mix of fixed deposits and a PPF account, yielding 6% annual returns.
Step 1: Setting goals and allocating funds
Rajesh decides to prioritize his goals:
Building a retirement corpus.
Saving for his children’s education.
Purchasing a house in 10 years.
Step 2: Applying the 7% annual return rule
Rajesh learns that equity mutual funds historically provide higher returns than his current investments. He reallocates a portion of his savings into a diversified equity mutual fund portfolio. By doing so, he targets an average return of 7% over the long term.
Step 3: Practicing the 5-year rule
Understanding the importance of patience, Rajesh commits to keeping his equity investments untouched for at least five years. He builds a contingency fund equivalent to six months’ expenses in a liquid fund to avoid prematurely withdrawing his equity investments during emergencies.
Step 4: Top up SIPs for accelerated growth
Rajesh adopts the practice of topping up his SIP investments annually by 10% to 20%. This ensures his contributions keep pace with inflation and accelerates the wealth-building process for his financial goals.
Step 5: Balancing 3 financial priorities
Rajesh allocates his savings efficiently:
He starts by contributing 50% of his savings toward retirement.
Next, he allocates 30% to his children’s education fund through SIPs in equity mutual funds.
Lastly, he directs 20% toward saving for a house down payment, investing in a mix of debt and balanced funds to ensure stability over the 10-year period.
Results
By following the 7-5-3-1 rule, Rajesh achieves clarity and discipline in his financial journey:
Retirement: He builds a corpus that ensures financial independence during his golden years.
Education: His children’s education fund grows steadily, avoiding the need for costly education loans.
Home purchase: His 10-year investment plan for a house aligns perfectly with his timeline.
Conclusion
The 7-5-3-1 rule is more than just numbers; it’s a mindset. It teaches investors to aim for realistic returns, stay patient, and focus on specific goals while leveraging practices like annual SIP top-ups. For individuals like Rajesh, this framework simplifies financial decision-making and ensures a secure financial future. By embracing this rule, you too can navigate the complexities of investing and achieve your dreams with confidence.
(Dr Harshit Kapadia is a metaphysics consultant of Conscious Vaastu, Yuen Hom and Sam Hap Style of Feng Shui)
