19 May, 2011

USE Financial planning tenets to keep your finances ship-shape

Have you ever seen a military vehicle with paint peeling off it? Chances are, you haven’t. The services maintain their vehicles well and keep them painted and well-oiled always. Even their living quarters, grounds and other utility areas are clean and neatly turned out. There is an important lesson to be learnt from the armed forces – one needs to give time and attention to the truly important aspects that are crucial to success.

For individuals, it is their finances which is important. Most people own up that money is very important for them. Yet, a significant majority neglect their finances and allow it to descend into chaos and ruin. There are a few pointers which could be used to tackle finances and keep the money green and growing.

Money Management - Allowing money to remain in the savings account for long is criminal, for it earns low interest. A better proposition would be to invest in sweep-in deposits in the bank. This money is available whenever one wants. Till that time, it will earn higher interest. Alternatively, if one could set up an overdraft account with one’s bank, it is even better. Here, one could borrow from the bank for the period when it is required. The interest needs to be paid only for that period. This is a cost-effective option. With an over-draft account the balance in one’s account can be stripped to the bare minimum. The other way is to invest in money manager funds of Mutual funds, where the returns post tax is higher than returns from SB account as well as even the sweep-in deposit.

Debt - It is a great idea to use credit cards with discretion. The best way would be to pay the bills before due date, instead of rolling it over. Also, any purchases should ideally be done with money accumulated through investments, over time. Saving Rs.2,000/- for 18 months for a LCD TV is a better idea than simply swiping the card and paying EMIs. In the former, there is no pressure and is a disciplined approach - the purchase happens only after accumulating the required sum. Swiping the card approach is far more dangerous as there are no limits here and can go out of control. For all items of consumption, this approach of saving for it fully or substantially before buying would be the ideal approach.

Even in case of buying a home, one needs to exercise caution, though an asset is being created. Many people get carried away when they see properties and like them. They stretch beyond what would be easy to service. A better approach would be to clearly draw the lines on how much one is willing to spend for a home and stick to it. Even here, it is a good idea to accumulate money for a substantial down payment, instead of the mandatory 10-15%. It is good to go one step at a time. Buying a smaller, affordable property first and trading it up over time, is the sane thing to do – it is easier and much less stressful.

Investments – First the don’ts. Don’t invest in every scheme that comes into the market. Don’t invest because your friend/ colleague is investing. Everyone is investing and so it must be good is no reason to invest in a product. Find out how much you will get after tax from the product. Find out what is the risk. Is the tenure suitable and is there liquidity? After considering all this only, one should invest. A bank FD offering 9% would translate to only 6.2%, after tax. Consider all options that could give good post-tax returns. It is often found that people are inclined towards debt instruments like FDs & bonds, property, equity etc. People who invest in a balanced way are in minority. A proper allocation towards all assets is imperative. That will achieve diversification. Running away from equity is counter productive. Though the risk is higher with equities, it goes down over time. Over the longterm, it is equities that beats inflation. Investing in Equities through the medium of Mutual fund schemes is advisable for the normal investor.

Insurance – Lot of people confuse insurance and investments and get into trouble. Also, people still invest in insurance primarily for tax breaks. Insurance is to provide security to the family if the primary income earner were no more. Term insurance is one of the simplest & cheapest products which addresses this very well. Take adequate life cover to protect the family. Similarly, medical insurance is a must today. Though these premiums may not get returns, it is not to be seen as a wasteful expense. Do we see our home as a wasteful expenditure. Proper insurance is a security net and you could consider the premium paid as the rent you pay for it.

Liquidity & provisions – Liquidity of about three months expenses is recommended in most cases. In cases where there is uneven income, a higher liquidity margin would be suggested to take care of any cashflow problems. For big upcoming expenses, provisions need to be made by way of allocating investments that would mature just before the money is needed. Proper provisioning will ensure that there are no sudden financial shocks.

Once you take care of these, then life would be a breeze. Finances are important. Like the armed forces, you need to spend some time on it to ensure that your finances are in fine fettle. Good tending ensures that you are on a nice velvet patch, in future. Ignore these basics and it will come back to haunt you.

Article by Suresh Sadagopan ; Published in DNA Money on 29 April, 2011

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