Beginner’s Guide to Managing Money
The youth of today is vastly aware of the dreams he/she needs to achieve in life. But, these dreams cost a lot in today’s times. Be it costly foreign education, cost of marriage, cost of raising children, or planning for own retirement, youngsters have a long road ahead of them with these expenses. The good news is that they also have age on their side. The power of compounding shows that commencing with investments early and managing money smartly, has the potential to let the investor reach individual goals easily. So even if you don’t earn a very high income, you can be strategic in money management and still achieve the dream house or car that you like.
What is money management?
There are two key aspects to every individual’s finances – what is earned and what is spent. These two form the basis of wise financial planning. Now within the income you have to look at components that can boost your net income (e.g. lowering taxes, availing of food coupons in salary CTC, investment) or lower your expenditure (e.g. preparing a budget, paying off debt, saving for the future, knowing the difference between wants and needs).
A meticulous assessment of these components and optimizing them in the best way possible is nothing but money management.
How you manage the money earned and spent speaks volumes about your financial sanity. With it, your financial health and stability will remain in total control and you will be in a better position to fulfill your dreams the right way.
Some useful tips for managing money
Many people fear having a budget in place. The reasons can be many. From not knowing how to do it, to not being able to abide by it, to not budgeting correctly, this small exercise will help you out:
a. Understand the concept
A budget is nothing but a listing of your expenses and income. This lets you know how much you are saving, and if you aren’t saving then where are you spending.
b. Use tools
While an Excel sheet is a great way to start, it is tedious and you need to start from ground up. Today, there are a lot of personal finance tools and expense manager solutions that are available online. These already have the basic groundwork done. All you need is to feed in the data and see interactive reports giving you various insights about your financial health.
c. Categorize wisely
The three broad classes to group your expenses will be necessary, discretionary, and leisure. It is important to allot a fixed percentage for these three groups and make sure you don’t go overboard. Not sure how much to allot to what group? Then simply keep recording all expenses happening daily, and in 4-6 months you will have a fair idea to align your categories’ allocation to actual expenses.
Once you have a budget in place, you will know exactly how much you save regularly. This, in turn, will help you determine what you need to do in order to meet your long-term goals. So if you need to buy a house in 10 years’ time, then it is important to know how you will invest your savings to have this amount in hand within the stipulated time frame. This is a classic example of framing your goals and using your savings to achieve this goal.
Different time horizons need different types of investment as below:
a. Short Term
For funds needed within 1-3 years, you need to invest almost fully into debt-based and liquid investments. You cannot invest in equity as equity will yield favorable results only in year 4 or above (in general)
Asset Allocation = 100% debt or 90% debt + 10% equity
Type of investments = Fixed Deposits, Recurring Deposits, Liquid Funds
b. Medium Term
Some of your goals may come up in 4 to 7 years. For this you need to invest in a judicious mix of debt + equity. This will help you meet your medium term financial goals.
Asset Allocation = 60-70% debt + 30-40% equity
Type of investments = Balanced funds, ELSS
c. Long Term
Long term investments will show impressive yields if equity forms a majority of the portfolio.
Asset Allocation = 75%-80% equity + 25%-20% debt
Type of investments = Equity funds, PPF
Make sure to factor in inflation when you are framing your financial goals. Assume that costs will increase 8% every year. It is a given that the amount of goods that a specific amount of money can buy will keep going down. So factoring in inflation will help correct the course and help you set a realistic target
3. Avoid and pay off debt traps
At an early age when responsibilities are low and income is high, there is a tendency to splurge on many products that you really don’t need. It is important to avoid this mindset. Also, keep a credit card only to pay off emergency expenses. This will help you stay out of debt traps and leave you hassle-free. Two other ways to eliminate the debt trap include:
· Don’t roll over credit card payments
How many times has it happened that you have spent almost as much as your credit limit simply because you could? This is why it is very easy to fall into the credit card debt trap and extremely difficult to get out of it. If you still have a card outstanding amount, then make sure to pay it at the earliest without rolling it over to the next cycle. The steep 3% per month interest rate will make your overall purchase an exorbitant one.
· Use a mix of debit and credit cards
While paying with a credit card will sound troublesome, you will note that sometimes it is essential. With it, you get quick cash to pay for emergency or unplanned critical expenses. Hence keep a credit card handy. For all other purchases, use your debit card or net banking.
4. Save for emergency
In your eagerness to earn money and spend on big-ticket purchases, you may lose visibility of planning for the unplanned. These unplanned emergencies can range from a medical emergency to sudden job loss. So it will be good to start planning for emergency expenses. Building this emergency corpus will need to take priority even over short-term goals.
You need to have 6-8 months of salary in this emergency corpus that must not be used for any other purposes. This amount needs to be liquidated easily so that you have access to the money in the time of need. For this, you can opt for a sweep-in bank account, liquid fund, or short-term debt fund.
5. Get the right insurance cover
Keep this golden principle in mind – insurance is to cover your life not give you returns. Once you acknowledge this underlying guideline, you will make the right choice with your life insurance. If you are a sole earning member, married, or have dependents, then insurance is a must for you.
The good news is that the earlier you start, the lower is the premium you will have to pay for a specific coverage amount. Some of the essential coverage you can opt for include:
Life insurance policies come in three types:
a. Term plans
They have a very low premium and a good policy coverage. In this type there are no returns provided. The amount is paid off only if the insured person deceases.
b. Traditional plans
Endowment and moneyback plans come with a higher premium and have a lower coverage. The returns depend on market performance
c. Equity-linked plans
ULIPs come with very low coverage and high premium. The returns on this type of coverage is the highest as these come typically with stock market linked performance
A life insurance coverage should typically be 5-7 times your annual income.
A typical plan protects the insured person and his family against hospitalizations costs and medical treatment expenses. The double problem of urban lifestyle disease growth plus high medical treatment costs makes it necessary to go in for health insurance. When you start off you need to have a health cover of Rs. 4 to 6 lakhs. If the number of dependents increase (e.g. after marriage) you need to increase this amount.
· Critical illness plan
This is another plan that comes in two varieties – as an add-on with a health cover or life insurance, or as a distinct package. While you can disregard this plan in your 20s, you need to consider this plan in your 30s so that you are better prepared for ailments occurring due to a sedentary lifestyle or stress at a younger age.
6. Fine tune salary structure
Today many companies allow employees to fine tune the CTC within the broad categories of
- Basic Pay
- HRA (40% – 50% of the basic)
- Leave Travel Allowance (LTA), Medical allowance, Conveyance allowance,
- Dearness Allowance, and
- Special Allowance.
Also there will be standard deductions such as
- Professional Tax
- EPF (12% of basic)
Now, you can fine tune the salary to achieve one of the two objectives
- Increase take home salary and bring down retirals
- Decrease take home salary and increase retirals
Both of these come with their own approach, pros, and cons
a. Increase take home salary and bring down retirals
WHY – Get more salary in hand
HOW – Opt for food coupons and applicable allowances
PROS – They bring down tax liability and improve take home pay
CONS – Since basic and related items like HRA and EPF come down, you would be viewed less favorably in case you want to opt for car or home loans
b. Decrease take home salary and increase retirals
WHY – Optimize long term savings
HOW – Increase your PF contributions (While employer’s contribution is capped at 12% of basic, employee contribution can be increased). If you don’t plan to stick around for as long as 5+ years then remove gratuity component.
PROS – With better Voluntary PF contributions you earn the same rates as PPF but aren’t limited by the PPF’s lock-in period of 15 years
CONS – While your retirement planning will be optimized, you will be left with lesser take home pay every month.
To sign off
While this primer may seem pretty exhaustive, the good news is that you aren’t alone in your money management quest. With rising influence of technology, you can definitely find a great money management app that will take the hassles out of maintaining a good record keeping to know where you stand with regards to your savings, income, and investment.
Always remember, sound money management won’t come overnight. It takes some small steps throughout your 20s and 30s, so that your later life can be easily manageable and you will be ready for all planned and unplanned situations in life.