10 “Personal Finance Commandments”
A few thousand years ago, God gave Moses the Ten Commandments. As the year draws to a close, FinEdge brings you “Ten Commandments” of a different kind! Follow them; and we promise you that you’ll be a few steps closer to Financial Freedom over the next 12 months…
Commandment 1: Thou shalt not overspend…
Warren Buffett once famously said – “if you buy things you don’t need, you’ll soon have to sell things that you need”! This commandment might seem like a no-brainer, but it’s of utmost relevance from a personal finance standpoint. Curb unnecessary expenditures and live within your means. Don’t leverage your finances by over-borrowing – limit your monthly EMI’s to below 20% of your net monthly income. And lastly, resist impulse purchases – sleep on your decision and decide the following morning instead.
Commandment 2: Thou shalt establish a budget…
Boring as this task sounds, it’s vital to establish a “personal budget” which will help you track your sources of income and expenditure. Without a budget, you might end up “flying blind” and spending more than you earn. This might lead you to take on expensive credit card debt which could set off a toxic cycle of incurring and repaying loans. It’s true - even a small leak can sink a large ship! Be thrifty, most wealthy people are.
Commandment 3: Thou shalt create an emergency fund…
Emergencies never come announced. Don’t succumb to the “it-happens-to-everyone-else-but-me” syndrome! Steadily put together an emergency fund which should be highly liquid and easily accessible. Resist the temptation to liquidate this fund for frivolous expenditures. Always have a minimum of 6 months expenses (including EMI’s) safely parked away in a non-volatile liquid fund.
Commandment 4: Thou shalt automatically save at least 20% of your monthly income&hellip
We call these magic ratios “reserve-surplus ratio” and “savings-surplus ratio”. In a nutshell, make sure you have at least 20% of your net income left over after provisioning for all your monthly expenses as per your budget. That’s not enough though; you must save this leftover cash on auto-mode. Think about it – your EMI’s are debited from your account automatically every month, so why not your savings?
Commandment 5: Thou shalt repay debt…
Debt is nothing short of financial cancer. Steer clear of expensive loans such as credit cards and personal loans. Aim to accumulate lump sums to pre-pay car loans and home loans too. Debt repayment must be a top priority goal in your mind. Unless you like donating money to banks and lending institutions, that is!
Commandment 6: Thou shalt insure adequately…
Consult a Financial Planner to determine your appropriate level of life and health insurance. Your life cover should be enough to take care of at least 10 years inflation adjusted expenses for your dependents PLUS outstanding liabilities PLUS the cost of achieving important future goals for your dependents (such as education)! Ironically, most of us Indians are heavily under-insured in spite of the widespread popularity of insurance products as savings tools. Many of us do not have adequate health cover either. With escalating medical expenses, an unexpected healthcare related contingency could potentially lead to significant financial strife. Cover your bases in 2015!
Commandment 7: Thou shalt educate yourself…
In 2015, resolve to educate yourself on financial matters. While we’re not proposing that you glue yourself to financial news channels all day long, it’s important to build a basic level of awareness about important financial events and trends (such as the recent drop in crude prices) in order to understand their impact on your investments. Also, self-education on the nature of various different financial products will ensure that your hard earned money gets channeled into high quality investment products that are aligned with your risk appetite and your long term objectives. Don’t let anyone take you for a ride!
Commandment 8: Thou shalt buy the right products for the right reasons…
A 2012 survey by a global Financial Planning major yielded a valuable insight – “Indian’s tend to buy the right financial products for the wrong reasons”. For instance, there’s a mad rush to purchase life insurance policies during the last quarter of the financial year to fulfill tax savings requirements under section 80C. While life insurance may not necessarily be a wrong product to purchase (depending on the type of insurance product and your own life situation, of course), there are definitely more lucrative options available for fulfilling your 80C requirements! Similarly, a recurring deposit yielding 6% post tax return might not necessarily be a poor product per se, but it surely isn’t the best savings tool for a goal that is 10 years away! Here’s a simple thumb rule – while purchasing any investment product, ask yourself why you are purchasing the product and whether there are any better alternatives available to fulfill the same purpose. A qualified Financial Planner (not an insurance agent!) might help you get a clearer perspective.
Commandment 9: Thou shalt organize your records…
A disorganized portfolio can wreak havoc on your personal finances. You could end up overexposing yourself to a single asset class, or worse, you could actually end up losing hard earned capital. We’ve actually encountered clients who kept purchasing life insurance policy upon policy only to realize their savings haven’t actually grown at all even after 5 years! Even worse, many of these clients weren’t even aware of important elements of their savings plans such as fees, lock in periods or annualized returns. We recommend that you organize all your investment documents, monthly budgeting sheets, loan account statements, bond certificates and other financial documents neatly and you’ll be able to control your personal finances a lot better. Better still; create an online repository of all your investment documents for efficient tracking and management.
Commandment 10: Thou shalt let go of worthless investments…
“It’s already gone down so much... there’s no point selling now... I’ll just hold on until it breaks even...”
“I need to get at least Rs. X for this investment… I’m not willing to sell below this price…”
If you’ve ever caught yourself rationalizing investment decisions in this manner, it's because you’ve succumbed to the classic “sunk cost” fallacy. This mental barrier is what prevents us from bravely letting go of poor investments with poor future prospects! In the end, remember that the market is above us all. Wishing that your investment will rise in price (or will sell for the price that you want it to) won’t actually make it happen! Whether it’s a poor performing ULIP which charged an exorbitant upfront fee, a low return fixed deposit with a nominal exit charge, a stock in a sinking company that you’ve held on to for dear life, or a piece of real estate you’re better off not owning – resolve to hit the ‘liquidate’ button and start off with a clean slate! Take a dispassionate look at your portfolio and weed out the investments that don’t belong.