Managing money may not have been one of our worries in the early stages of our life and thus, we may have developed some habits which may not be well suited to the current times and needs. So the question comes, what habits can we develop now to take better control of our money. Here are a few habits one can focus on:
1. Budgeting
2. Prioritize Spending
3. Using Debt Wisely
4. Pay Yourself
[1] Budgeting:
Budgeting starts with most basic steps of managing money, and goes to an advance level of allocation of money for various goals. It includes following steps:
A. Recording Expenses
B. Classification of Expenses
C. Setting Limits
A) Recording Expenses:
So, we start with the most basic steps of accounting for our expenses. If you have been spending without recording your transactions, first step is to record your outflows and inflows every day. This exercise may seem tedious in the beginning but, going forward this will become the most
useful and effective tool towards the total control of your money. Once you have your expenses recorded at one place move to the second step of clubbing your expenses under various heads.
B) Classifying Your Expenses:
Purpose of various expenses can be similar and different. We can classify all of them based on their importance in our lives or based on our own obligation towards them. For example: We may not be able to postpone home loan EMI payment but we can postpone the home theatre purchase to another month. Another way of classification (more popular one) can be by putting them under heads depending on the area of life they relate to. For example: Rent, home maintenance, kitchen expenses can be put under Household Expenses, similarly travelling and fuel expenses can be put under Commutation expenses to better understand the area of spending.
Major Expense Heads in an Individual Life are as under:
> Household Expenses
> Utilities Expenses (incl. electricity, water, phone, mobile etc.)
> Travelling/Commutation Expenses
> Lifestyle Expenses (incl. outings, weekend exp., dinner etc.)
> Education/Children Exp.
> Subscriptions
> Insurance & EMIs
> Other regular Out-flows
C) Setting Limits:
Different expenses have different value in our day to day life, for example: Money spent on commuting to office from home is a choice between taking a metro, auto, taxi or own car. Similarly some expense, do give us choices some do not. Going forward you’ll find that most expenses give you options, though, exercising these choices may be easy or difficult at times. Providing a limit to the expense head in the beginning of the month will give you sufficient motivation throughout the month to keep it within that limit.
[2] Prioritizing Spending:
Priority of expenses depends on the obligation or avoidable and unavoidable nature of expenses. Like we discussed above, some expenses can be postponed and some cannot be, will define the importance of that expense in your financial life. Likewise, EMIs, Insurance Premiums, Children’s School fee etc. have priority over, weekend dinners and outings, but kitchen expenses are even more important.
[3] Using Debt Wisely
Use of debt is almost common in today’s lifestyle to provide for various expenses and investments. Problem with the
Debt comes in two forms:
A. It can make things expensive
B. Creates a long term obligation
Use of debt can be tricky as you’d not like to take a long term obligation for purchasing something which will depreciate over time, for example: Purchasing expensive electronic items on EMIs. With such purchases you will quickly find that the obligation of paying EMIs for long period is a toll on your savings and may create more dissatisfaction than satisfaction from material ownership.
When and How to Use Debt?
Most intelligent place to use debt is to purchase assets that:
> May increase in value over time,
> Give you tax breaks and
> Are too expensive to be paid for in one go.
Best example for the same is real estate. But this will also mean that you can make certain investments which are riskier than a deposit but have the potential to return more than the interest paid on borrowed money. But investing by borrowing is an advanced concept and not recommended for people with weak cash inflows.
How to avoid use of Debt?
The best way is to plan in advance. Though, it’ll be difficult to avoid use of debt in all possible purchases, but planning in advance will allow you to not only avoid huge amount of debt, but will also allow you to purchase something better. Also for purchase of assets which are going to depreciate early planning will ultimately save money as well, as you can earn interest on the savings you do towards it
[4] Pay Yourself
This is a method which gives you a definite amount of money regardless of total inflow, and even when you are trying really hard to save more and more money, paying yourself first will enable you to be satisfied even with major cuts in expenses. This is what you need at a bare minimum to enjoy life as it is and not just live it for money.
The Amount you pay yourself will depend on couple of things like:
> Your Personal Expenses
> Expenses for activities to de-stress you
These are generally the expenses that keep you going and help you achieve satisfaction from your day to day life. For example: when you go to your business or office, you cannot just roam around with an empty pocket, some or the other petty expense, where it’s about an occasional coffee with colleagues or fare
for an urgent commute you will need some money which cannot be planned.
Improving Outflow to Inflow Ratio
This is the ultimate objective of whole budgeting exercise. You would want to improve your savings ratio to meet your future demands. Since, we are focusing on good financial habits, budgeting counts as the most basic and most important one. All habits and their consequential purposes as discussed above can be summarized as follows:
1. Plan in advance
2. Budget your expenses
3. Prioritize Your Expenses
4. Avoid Debt for small expenses
5. Pay Yourself
Any kind of habit takes time to sink in and become a part of your conscience. Financial habits are no different, what is required is practice and if you sincerely practice, within no time you will be living them as per your convenience. Good thing is, small concessions now grow into huge benefits later, and this is what good financial habits are all about.
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Everything gets measured. Thats' how things work, information is collected, decisions are taken; all based on measurements. Every thing around us, whether it is physical or non-physical has a measure.In the field of finance & corporates, these measure assume a great significance. There are measures for evaluating stocks, valuations of companies, credit quality of lenders, returns potential for opportunities, and so on. Most of the measures are in form of ratios like for eg., Price to Earnings (PE) ratio, Dividend Yield ratio, etc.
Amidst all these measures, have you ever wondered about how can you evaluate your own financial health? What measures would be appropriate for you? Well in this article, we would be presenting few measures that you can use to assess your own financial health. We hope, our readers would take the effort of actually measuring their financial health after reading this article.
RATIOS FOR ASSESSING FINANCIAL HEALTH:
EMERGENCY FUND RATIO
Formula: (Cash + Bank Balance) / (Monthly Living Expenses)
Ideal Value: 3 to 6
This ratio measures your ability to pay for expenses with cash in hand.
This ratio indicates an individual’s ability to meet its' monthly expenses in case of an emergency or a catastrophe. Typically, one should have enough cash + bank balance to cover for 3 to 6 months of living expenses. There is no exact measure but typically would be higher for those with high chances of unforeseen expenses, variable income, change in job or unemployed, start-ups, etc where risks are higher. Those with stable jobs and settled in life stage can follow the ratio at a lower end. It does not include voluntary expenses like those on entertainment, vacation or those that can be avoided, if needed.
LIQUIDITY RATIO
Formula: Liquid Assets / Net Worth
Ideal Value: 10% to 20%
This ratio helps a person to know his financial liquidity.
Typically any person would be investing in multiple avenues / asset classes and products – both financial and non-financial. Prudent personal finance planning requires us to maintain a certain level of liquidity in our holdings to face any unforeseen financial challenges. Investments in say property can be a good investment avenue but lack of liquidity is its' biggest negative. Typically, we must have at least 10% to 20% of holdings into liquid assets/products which can be redeemed at a short notice. Anything less is not healthy.
Liquid assets can include all cash (near cash assets), equities, Equity Mutual Funds (except ELSS with lock-in period, FMPs & closed-ended funds), Debt Funds and other assets which can be redeemed within three to four working days.
SAVINGS RATIO
Formula: (Amount invested per month) / (Total Income per month)
Ideal Value: 20-30%
This ratio indicates the savings made from the total income earned for a given period, say month.
Every family must save some portion of their income to ensure some wealth creation over time. AThe extend of savings depends a lot on the income earned, life stage,expenses of the person and so on. A minimum 10% can be considered as a must while we must aim for at least 20-30% savings from our total income. The savings can be in form of cash, bank balance, mutual fund, etc. Total income includes income earned through business, profession or in the form of salary, bonus, EPF contribution, interest, dividend, rent/royalty and any other form of income.
DEBT SERVICE RATIO
Formula: (Total debt payments /EMIs) / (Family Gross Monthly Income)
Ideal Value: Below 40%
This ratio shows the ability of a person to pay the loan installments on a regular basis. It indicates how much percentage of your monthly income is used for paying loan EMIs. Typically, the disposable income of a family would be portion which remains after paying the EMIs as such payments cannot be avoided. The lower this ratio, the better it should be for you to manage your finances and save. Typically you will have to manage your investments and expenses with the remaining amount. The lower this ratio the better your debt management skills. It is advised that debt servicing should not take up more than 40% of your income.
SOLVENCY RATIO
Formula: (Financial Assets) / (Total Liabilities)
Ideal Value: >= 1.5
This ratio assesses the total assets and total liabilities to find if the person has the ability to pay off his debts.
The higher the ratio, the better is the person's financial situation as the ratio indicates the debt carrying capacity of the person. Ideally, the total debt on a person should not exceed 50% of his disposable /financial assets. A ratio of less than 100% simply means that you are in a bad financial situation and you need to get rid of your debt soon. A higher ratio of over 150% would mean that you could easily sell of some of your assets and pay off the debt.
NET WORTH
Formula:Total Assets (less) Total Liabilities
This last measure ie., Net Worth, we are covering is not a ratio but an important direct measure of your financial strength. It is the amount left after deducting total liabilities from total assets. Your net worth is a snapshot of your financial life at one moment in time, a single number representing your financial health.
Net worth is a concept applicable to individuals and businesses as a key measure of how much an entity is worth. A consistent increase in net worth indicates good financial health; conversely, net worth may be depleted by losses /liabilities or a substantial decrease in asset values relative to liabilities. One can use the measure to set say yearly Net Worth targets or to track changes to find if you are getting wealthier or not.
CONCLUSION:
The personal finance ratios help you to evaluate your financial position and take next steps. The ideal ratios can be used as general targets and you can then plan your finances / portfolios accordingly. To keep a period record of your ratios and tracking them over time can reveal a lot of information / insights into your financial situation. Only with proper information and insights can you plan and take measures to improve your financial health.
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As it is said there are two unavoidable events of human being's life cycle : Death & Retirement. Although we can not really predict the first, we can really foresee our retirement and plan for it.However, retirement, although the most important and unavoidable event of life, it mostly remains unplanned due to other priorities in life. We plan for all important events of life - be it buying a home, planning for kids marriage, but fail to plan for this most challenging part of our life-stage . We all need to retire in peace and when asked we all would like to have a happy retired life but without quantifying the same in financial terms definition of 'HAPPY Retired Life' remains very vague.
But before we go ahead and discuss about how to go about retirement planning and things to consider, lets try to understand at first as to why do we need retirement planning.
Compared to yesteryears during the period of high interest rate region planning for retirement was much easier with fixed income products offering interest rates as high as 12-13%, which have gradually come down now and expected to fall further in future. Against this, life expectancy of an average Indian has gone up with medical advancement. Now aspirational levels have gone up as people want to fulfill their dreams and hobbies during their retired life, which they were unable to do during their professional life. Let us summarize the Why factor of retirement planning as under:
- Falling interest rates (Interest rates on fixed income products have now become market linked and have come down considerably in last one decade or so).
- Aspirational levels are going up with more and more people wanting to pursue their hobbies/dreams during their retired life.
- Change in social structure with growing urbanisation, trend of nuclear families with children often staying away from parents.
- Higher life expectancy due to advancement of medical science.
- Ever increasing medical cost and 78% of total health expenditure is privately funded.
- The most important factor: Inflation
Among all, inflation can be considered as the most important factor affecting retirement planning with ever increasing cost of living for developing country like India. With an average inflation rate of around 7%, your monthly expense of around 25000 can grow to around 1 lakh in 20 years time and close to 2 lakhs in next 30 years.
(Inflation assumed @7%)
As can be seen from the above graph just to maintain the same standard of living for a family with monthly expense of .25000 one would require 1 lakh per month after 20 years. Again this is just with an assumed inflation of 7%.
This was about the importance of retirement planning. Now another important question to be answered is how much retirement kitty should one have? Although there are no simple answers to this as there is no single figure that can apply to all. Every individual has to calculate on his/her retirement corpus requirement after considering the following important factors:
- The age at which one needs to retire.
- His/her current life style. (Mainly monthly expense)
- Assume realistic rate of return during your working life as well as during the retired life.
- Rate of inflation
- Consider any of your current retirement savings plan (pension plans, insurance, provident funds etc)
- Any specific dream/hobby one likes to pursue during retired life.
(Note: Assume that the above list is not comprehensive and just for example purpose. One needs to consult his adviser to do know about retirement planning process)
After assigning specific numbers to all the above questions one can arrive at retirement corpus required and then arrive at investment required to be made with the assumed rate of return.
The idea of retirement fund is that the money should last for all of our retirement years, meeting our expenses. The income from kitty and withdrawals from later years should match the expenses (growing with inflation) in post retirement years.
This is very critical, since with better medical services, average retirement years have increased and it is possible that a person retiring at say age 60 would easily have nearly 30 years as retirement. Developed countries have higher life expectancy, something India will sure achieve in the next coming decades. The criticality can be very simply understood by acknowledging that we may normally have 35 working years (age 25 to 60 years) in which we have to save for the 30 retirement years (60 to say 90 years) when we will not be working. Thus it is very critical that we realize this requirement and start planning immediately. Ever increasing cost of living will only add to our misery during retirement years when we mainly have to rely on our savings without having any major source of additional income.
Be vigil and open for course correction:
To arrive at a retirement corpus is just first stage of planning process. As we all go through different phases in life it is very important to keep one self open to make necessary changes on a regular basis. Major life events which require modifications in retirement plan are:
- Change in employment status ( One can increase contribution with promotion/increment in job)
- Change in family status (Getting married, arrival of a child etc.)
- Change in tax laws
- Getting any lump sum financial benefit through inheritance
Retirement Planning Options Available:
There are different retirement benefit solutions available in the market like insurance products aimed retirement benefits, planning through SIP in equity mutual funds, pension plans, employer sponsored retirement benefits etc.
As retirement planning is mostly done with long term investment horizon of above 5 years it should ideally be done by getting maximum exposure to equity as an asset class as over long time horizon equity has the potential to outperform all other asset classes. Investing systematically on a monthly basis through SIP route in equity mutual funds can benefit investors by taking advantage of power of compounding. Although one is always advised to keep his/her asset allocation in check to make sure that one does not overboard on a single asset class.
Another idea is to create assets that will give returns post retirement, like property, which can be put on rent or land which can be farmed, etc.
Conclusion: Retirement planning is an ongoing, lifelong process which requires commitment, patience and consistency on part of investors to reap rich dividend of final payoff of retirement kitty. No matter how big retirement corpus requirement may look like, one needs to start at some stage no matter how small that start may be. So don't wait for the right opportunity or the right time to come as the right time is NOW to make your retired life comfortable.
Financial literacy is regarded as an important requirement for the effective functioning for any economy and society. Over the years, financial literacy ensures supports social inclusion and enhances the well-being of our communities. While financial inclusion is the primary criteria while evaluating the level of development & progress of any economy, true financial independence cannot prevail in absence of literacy. In this article, we shall be taking a closer look at what financial literacy truly means and the advantages of it.
What is financial literacy?
Financial literacy refers to the ability to make informed judgments and to take effective decisions regarding the use and management of money. It thus includes the awareness, knowledge and skills to make decisions about savings, investments, borrowings and expenditure in an informed manner. In other words, financial literacy would mean that you understand the risks & rewards associated with every monetary decision and are also aware of the other options available to you.
Signs of financial illiteracy:
- Lack of awareness upon the need and importance of various financial services/ products.
- Lack of access or knowledge as to how to access to services/products
- Lack of knowledge and understanding of financial services/ products
- Inability to 'rightly' chose between alternate financial services/ products
- Inability to make proper assessment of the present & future financial situation
- Inability to understand the risks & rewards of any financial decision
Why financial literacy is needed?
The need for financial literacy is felt in developed and developing countries alike. Even if you have financial inclusion wherein you have easy and fair access to banking, investment and credit products, the real benefit can only be enjoyed if you are financially literate. There are many cases and even high chances that in absence of proper knowledge, one can be exploited by intermediaries and manufacturers, alike, leading to grave financial loses or crisis. In a world with growing financial inclusion, rise in number and complexity of financial products and a need for financial independence, financial literacy has become a must for everyone.
From a regulatory perspective, financial literacy empowers the common man and reduces the burden of providing protection and even grievance redressal to the common man by the regulators. It thus makes the entire financial system more efficient, disciplined and progressive. Financial literacy not only marks an improvement in the quality of life but also on the integrity & quality of the markets.
Who needs financial literacy?
Financial literacy is for anyone who has somthing to do with money. Thus, there is no one who doesn't need it since all of us are either engaged in earning, borrowing or spending money and do take financial decisions in our daily lives. Perhaps only infants, lunatic, godly men or old age dependents may be excluded from this group.
The focus of this article is on financial literacy that relates to you and your family members. Financial literacy is important for you, your spouse, parents and even children. Though one may argue upon the level and depth of the financial literacy knowledge required between different groups, an overall understanding is a must for all. With financial literacy, we have the following advantages
- Clarity of financial concepts and terms
- Making better financial decisions related to savings, investments, borrowings, etc.
- Accessing financial products & services easily, without fear or prejudice
- Building assets and wealth over time, leading to better financial health
- Overcoming vulnerability and avoiding exploitation by people around us
- Planning towards economic security to self and for family
Components for Financial Literacy:
The next question that arises is to what does financial literacy comprise of? You, most probably, may consider yourself as financially literate but may not be able to clearly outline the required knowledge surrounding it. We are presenting the broad outline to test oneself on financial literacy.
The following together can be considered as comprising financial literacy for any individual.
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The above may seem to be a very comprehensive outline but the idea is to cover all the major aspects of money that one has to deal in their lives. While detailed knowledge may not be necessary under each heading, one should however have the broad conceptual understanding of the idea and/or knowledge of options, as the case may be.
Conclusion
Financial literacy is the primary step for financial inclusion since introspection changes behavior which in turn makes people seek and receive financial services and products. Financial literacy can lead to financial wisdom and financial independence in knowledge. It will give the ability to manage money not just deal with it and to use skills & knowledge to take wise decisions for the future.
We advise all our readers to ensure that they are 'financially literate' in the truest spirit. We also encourage all the readers to make their family members, especially spouses, parents and growing children financially literate. One may use the outline shared to impart such knowledge. Indeed it would be a great learning for anyone that would otherwise take great time & experience to gain. This would help increase the economic space, self esteem and the confidence level of any individual and make him/her ready to easily engage in the mainstream of the financial systems.
Emotions is what makes us human. Unfortunately, emotions also make us bad investors. As a powerful force, emotions has the strength to often shadow intelligence, rationale and logic. And as investors, it does hurt us. It also drives our investment decisions most of the time, knowingly or unknowingly.
THE CYCLE OF MARKET EMOTIONS :
Markets tend to be more like ECG graphs in the short run while behaving like weighing scales in the long run. No one can actually predict what is going to happen in the short run but we mostly have a fair idea of where the markets are headed over long run. The short run for equity markets can be described as anything less than say 1 to 3 years of time, it can be days or months together. The long run will be say over 3 to 5 years. The longer the period, the better can be the predictability of growth trends and markets. A real problem arises when we observe sharp market behaviour in relatively shorter period of time, stroking the emotions within us. As market moves up and down, the emotions within us change. The worrying part is that these emotions are the opposite to what rational logic would suggest at different peaks & bottoms of the market cycles. Have a proper look at the image below which shows how the emotions of an average investor plays out in response to market movements.
THE UP JOURNEY :
At the time of beginning our investments, we feel optimistic about the future and decide to invest for the long run. Slowly, we as see the markets rising, we are more excited and thrilled. At this time we often also invest more money hoping the trend will continue. When it does, we feel euphoric as if we have really achieved something.
THE DOWN JOURNEY :
However, as the market cycle reverses,we at first are a little worried but we assure ourselves that the trend will be temporary. When it falls further, we deny any down cycle but we begin worrying about investments while continuing to hold them as long-term investors. Slowly, as market falls, we start fearing and then end up panicking when our profits have wiped out and investments are at big loss. We keep hearing and accumulating all the negative news around us and we feel the decision to invest was wrong and it would be now wise to stop our losses by selling – just like everyone else. When the markets reach the bottom, we fell we have made the right decision.
THE RISE AGAIN:
Slowly rationality and logic sets in and there is reversal of the trend after the bottom has been hit. We feel a bit disappointed as the market rises above the levels we have sold. Uncertain of the market direction, we decide to wait and watch. Slowly, as markets rise, our sentiments change from doubt to hope to optimism. After markets have risen well, we feel confident again in future to enter markets. We take our past experience as a lesson in investing and then invest again for long-term. Waiting for the history to repeat itself.
SAYING NO :
What we have learnt from history is that people do not learn from history. The saga of market cycles and emotions continues to play every time and the same herd behavior is often seen in the markets. Investors often jump into investing after seeing very attractive returns already made by others who invested much earlier. And when there is a fall, most are not matured and patient enough to see notional losses in their portfolio and react by selling.
Time in the markets rather than timing is what really matters in the markets if we want to make big returns. But to do this successfully, we have to control our emotions. Most of us are intelligent enough to make right investment decisions but do not have the temperament to carry it through. Dravid, perhaps the greatest middle over batsman from India, was able to survive the most challenging oppositions in foreign soils more because of his steady mind. He did not allow himself to get carried away even after tough sessions of low scoring or falling wickets. He is today remembered for that temperament and discipline.
THE KEY :
The secret of success in investing is known to everyone but practiced rarely. It is about being rational and logical when others are being emotional. It is about avoiding hear behavior by investing when others are selling and being grounded and rational when others are euphoric. Let us remember this simple behavioral aspect of investing and we will be good enough for being successful than a big majority of other impatient investors in the market. Let us hold steady and stay on the crease for long.
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We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful - Warren Buffett |
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