When it comes to money, Indians love rules of thumb. From age-old wisdom about gold being the ultimate store of wealth to modern investment shortcuts like the ‘100-minus-age’ rule for equity allocation, heuristics help simplify complex financial decisions. These mental shortcuts are useful but not foolproof—sometimes, they can lead to costly mistakes. The key is knowing when to use them and when to be cautious.
Heuristics in everyday financial decisions
We can think of our monthly income as a meal of plate where 50% is covered with essentials like rice, proteins and veggies; 30% is for something that you enjoy but is not necessary, like desserts, drinks, etc.; and the remaining 20% for leftovers to be used next day or as midnight snack in case needed.
Financial heuristics are simple rules that help people make quick decisions. For instance, the ‘Rule of 72’ estimates how long an investment takes to double by dividing 72 by the expected rate of return. The ‘50/30/20’ rule suggests budgeting 50% for needs, 30% for wants, and 20% for savings and investments. These heuristics have been widely used across the world, with some, like the 50/30/20 rule, gaining popularity in India as young professionals seek simplified budgeting strategies. However, applying these rules without understanding their assumptions can lead to financial missteps.
When heuristics work and when they fail
Heuristics work best when they align with real-world financial principles. For instance, the ’emergency fund’ rule, which suggests saving three to six months of expenses, is widely applicable, especially in uncertain job markets. But what about the ‘100-minus-age’ rule for equity allocation? It assumes that younger investors can afford to take more risks, but it doesn’t consider individual risk tolerance, market cycles, or economic conditions.
In India, where fixed deposits and gold are deeply embedded in financial culture, applying Western heuristics without adaptation can be misleading. For example, the ’10-5-3′ rule, which assumes 10% returns from stocks, 5% from bonds, and 3% from savings, is based on U.S. market trends. Indian markets have different risk-return dynamics, making these assumptions unreliable.
Behavioural research and the heuristic trap
Psychologists Daniel Kahneman and Amos Tversky, in their Nobel-winning work, highlighted that while heuristics help in decision-making, they also lead to biases. The availability heuristic, for instance, makes people overestimate recent trends—if the stock market is booming, they assume it will continue indefinitely. Indian investors often fall for the ‘recency bias’, chasing high-performing mutual funds without considering their long-term consistency.
How to use heuristics wisely
Instead of blindly following heuristics, investors should treat them as starting points, not fixed rules. For instance:
Adapt rules to your situation: The ‘emergency fund’ rule may need tweaking for freelancers or business owners.
Validate assumptions: The ‘100-minus-age’ rule ignores individual risk tolerance. A better approach is assessing risk capacity.
Combine heuristics with expert advice: Consulting a financial planner can prevent heuristic-driven mistakes.
Financial heuristics are powerful tools, but only when used correctly. While they help simplify decisions, blind reliance on them can be dangerous. As Indian markets evolve and financial products become more complex, investors must balance intuition with research and professional guidance. After all, the best financial rule of thumb is to think before you act.
Views are personal.
Hardeep Singh Mundi is an assistant professor and Yukti Agrawal is a PGDM candidate at the Institute of Management Technology (IMT), Ghaziabad.
