When it comes to investing in mutual funds, many beginners feel confused about where to start. To make the process easier, financial experts often recommend using simple rules. One such popular method is the 7-5-3-1 rule, which provides a clear path for beginners to plan their investments. Let’s understand this rule in detail.
What is the 7-5-3-1 Rule?
The 7-5-3-1 rule is a guide that helps investors decide how much of their income they should save and invest. It breaks down into four simple parts:
- 7% Investment Return
This part of the rule suggests that, over the long term, investors can aim for an average return of 7% per year on their investments. While returns may vary from year to year, historically, many mutual funds have provided this kind of return if held for the long term. It’s important to note that this is not a guaranteed return, but a reasonable goal based on past market performance. - 5 Years of Minimum Holding Period
The next part of the rule says that you should plan to hold your mutual fund investments for at least 5 years. This is because mutual funds, especially equity funds, tend to perform better when they are invested in for a longer time. Markets can be unpredictable in the short term, but they often grow steadily over the long run. By staying invested for five years or more, you give your money enough time to grow and avoid making decisions based on short-term market fluctuations. - 3% Withdrawal Rate
Once your investments start growing, you may want to take out some money for your needs. The rule advises that you should only withdraw 3% of your total investment each year. This is a safe rate that ensures you don’t use up your entire investment too quickly. By following this, you can enjoy the benefits of your investments while allowing the rest of your money to continue growing. - 1 Goal at a Time
Finally, the rule recommends focusing on 1 financial goal at a time when you are investing. Whether it’s saving for a house, your child’s education, or retirement, having a clear, single goal will help you plan your investments better. It prevents you from getting overwhelmed by multiple targets and allows you to make steady progress toward one specific financial objective.
Also Read: Top 10 Mutual Funds That Every Investor Should Consider in 2024 for Investment Â
Why Use the 7-5-3-1 Rule?
The 7-5-3-1 rule provides a simple framework for anyone who is new to investing in mutual funds. It removes the complexity and helps you focus on key principles:
- Patience: Holding your investments for at least 5 years allows your money to grow in value.
- Discipline: Withdrawing only 3% per year ensures that your investments last for a long time.
- Clarity: Focusing on one goal helps you stay on track with your financial planning.
Conclusion
The 7-5-3-1 rule is an excellent starting point for beginners who want to invest in mutual funds but are unsure how to go about it. By following these simple guidelines, you can develop a solid plan for long-term financial success. Always remember, though, that every investment carries risks, so it’s essential to stay informed and, if needed, consult a financial advisor before making decisions.