Despite all the numbers and what appears to be a mathematical problem, at the end of the day, personal finance, in my opinion, is common sense! Several online tools can assist the number crunching, both simple and complex ones.
The most important part of planning your personal finances is to figure out your own goals and where you see yourself in the near and distant future. This defines the direction for your money.
How does one start one’s financial journey? The first step is to learn the basics of personal finance. You can google the myriad resources available online. But, if you find this information confusing, reach out to professionals in the business.
Usually, people make the mistake of investing their money first and then learn through trial and error. This can lead to costly and irreversible mistakes or delays in investment due to which you may miss out on the benefit of compounding.
Compound interest is such a powerful yet neglected idea, that Albert Einstein famously called it “the eighth wonder of the world”. Warren Buffet says, “He who understands it, earns it ... he who doesn't ... pays it."
To begin with, take a pen and paper. Mind you, this is going to sound ridiculous till you actually do it! On one side of the sheet write your assets, which is all that you own, right from gold, real estate, FDs etc. and on the other side write your liabilities, which includes all that you owe others, like loans from friends, housing loans, credit card dues, business loans etc.
It’s all in the plan
Have a rough estimate (an exact estimate is even better) of how much you spend, on large expenses like rent, healthcare, schooling and luxury spends like entertainment etc. Make a note of your various sources of income too.
The amount of money you need depends on your unique circumstance like your age, earning ability and responsibilities. A simple method is to find out what are your future commitments are, including life goals such as marriage, children’s education, ageing parents, starting a business and your own retirement.
Now plot them according to and when they are due in the near-term, mid-term and long-term time spans and how much money you need for each. Keep in mind, that as we go higher on the income ladder, we need to account for our lifestyle expenses too – say a bigger car, holidays abroad etc.
How does all this information help? Firstly, it gives you a realistic idea as to where you are and what you must plan for. Secondly, it helps to divide your goals into different phases of life and make them realistic. If you are in your early 20s then marriage will be a few years away followed by kids a bit later.
Map this for all the significant phases of your life - single (few expenses), married (single or double income), married with kids (increasing expenses) and retirement (limited income, only expenses).
Take inflation into account
Whether you are employed, an entrepreneur or a homemaker this exercise is the most significant part of personal finance.
Say you are single and your expenses are around 30K per month. You decide to get married and have kids. Now think of all the possible expenses that will go up with more dependents and take inflation into account.
Newspaper headlines report that costs are rising by 5% every year but in reality, it is much more. For example, healthcare costs are going up by 15-20% annually and education by 10-15 percent. Inflation rates are often ignored while planning finances.
Plan an emergency fund
Always, have a financial plan for an emergency! We all live in the bubble that we will be fine. But what if your startup shuts down? What if there is a job loss due to lack of work or due to health reasons? How will you sustain yourself and your family?
Keep aside at least three to six months of regular monthly expenses in a contingency fund. People with uncertain earnings like entrepreneurs and people launching startups need a larger contingency fund.
Finally, we need to make an investment decision. What are the different investment avenues available? Each investment offers different returns and must be bought for a different purpose.
Real Estate – This investment is usually bought as a place of residence and needs a large sum of money.
Gold – This investment is mainly for ornamental purposes.
Fixed Deposits – These deposits would be for Emergency funds and short-term requirements.
Equity Mutual funds – These funds are for long term wealth creation.
PPF, ELSS – This offers tax benefits along with safe returns.
ELSS – This is bought for Tax benefits along with market exposure.
Identify what you are investing for and allocate your money to that category of investment. Too much or too little in one category can be dangerous. A mismatch in the purpose and the chosen financial instrument can lead to a shortfall when you need it. For example, India’s favourite mode of investing is the FD but it offers returns that barely beat inflation.
What about insurance investment? Firstly, insurance is not an investment! Basically, it is an amount one sets aside to cover the financial risk in case of an eventuality. If the breadwinner in the family is either no more or incapacitated, then insurance must replace his or her income.
Here we must say one crucial point that people miss, EVERYONE needs health insurance – kids, elders, ourselves. Anyone can fall ill, irrespective of age, gender, status, etc. With rising healthcare issues and costs, one must ensure adequate health insurance for the entire family.
Do you need your own house?
Owning a home is an Indian dream and still a top priority. The lovely ads which proclaim the urgent need to own that beautiful house with a pool, gym and lots of greenery, lures many Indians to invest in a house too early.
A home loan taken very early when you’re young and unsettled with growing family needs can quickly spiral into a debt trap. With a little disciple a regular investment done through a SIP, can offer better benefits and ensure forced savings as well.
Don’t forget your nominee and make a will too!
Any last points? Many people don’t know the rights of a nominee before they choose one. For some investments, like shares, the nominee is the direct beneficiary while for some others like deposits, PPF etc., a nominee is a custodian to pass on the investment to the legal heirs. Ensure you know the nominees’ rights, make sure the nominee has been informed and choose the right nominee. Most Indians don’t have a will.
Writing a will today is so easy – a pen, paper and two witnesses are all one needs. Registering it makes it more solid to dispute, if contested. Lastly, all family members must know about the various investments, insurance and other financial details to ensure a smooth transition.
While planning your personal finances looks like a humungous task it isn’t! All this takes just a few hours initially and then, when the systems are in place, one has to just keep adding or deleting the information!
Today there are so many apps and websites that are available even to tell us where we need to invest more or less. All we need to do is key in the details.
A parting tip: Set up a date with your future self! Get ready, wear your party shoes, pour out your favourite beverage, bring out your best pen and let’s talk about money.