07 August, 2012

Tenets for Financial Solvency & Wellness

Who would not want a comfortable life? We all aspire for it. But some of us are able to make things happen. Others, inspite of being good income earners, falter along the way and end up with sub-optimal results. Such people often wonder about those “others” who have almost magically stolen a march over them, even though they stood no chance to start with.

Parth was one such person. His good friend Amar, who was not exactly a high flier, had ended up with an enviable corpus at the portals of retirement. Parth just did not get it. Amar did not seem to have done anything spectacular and yet this ugly duckling had transformed into a swan.

Parth wanted to know the secret and Amar was willing to oblige. Amar shared with Parth,
  five tenets he followed for financial solvency and wellness. Here they are –

Invest first, then spend – Amar had been doing this almost from the start of his career. He had always earmarked a portion of his income for investment. Initially since the income was low, it was 10%. Later on, he had increased it to 15% and then 20%. He had accelerated to 30, then 35 and eventually 40%. He did not leave this investment to chance. He put that money aside first and only then spent the rest. That way there was no guilt feeling when he spent and there was no compromise about his future.

Discipline in investments – While putting aside some money every month is important, it needs to be invested in appropriate vehicles diligently. The easiest way is to invest every month, as soon as the salary came in. Amar used to do precisely that. He had setup Systematic Investment Plans ( SIPs) with MFs and was also investing in Recurring deposits ( RDs ). This way he did not get to see that money and was “not even aware that this money was there”. This money which he had started off with a modest Rs.1,000/-pm at the start of the career, ended with Rs.48,000/-pm, in the last year of his contribution.

Also, he had earmarked some of the investments for really long-term goals like retirement. He had invested in PPF & EPF for that and did not once dip into this kitty. For his other goals, he had invested in various instruments, which he had used for those goals. He always was willing to invest for the long-term. Amar had even some investments in equity, some of which were positively good for him. He had held on some shares for over 25 years in which he had received bonus and rights shares and the number of shares had multiplied like rabbits.  The dividends from these shares themselves had become significant source of income for him.

Don’t chase fads – Every once in a while, there are pet assets, which catch the fancy of the public. At one time, it was teak plantations & goat farms, at other times, it was farm land and of late - Gold. Amar was in fact quite vocal about this. He was telling Parth about the need to invest across asset classes and believe in their power to deliver results. Each asset class will perform at some point. One needs to wait for it. The temptation would be great to cash out from one asset class and put everything in another. Lots of people have cashed out from equity and put their money into gold. In 2007, people were transferring all their assets to equity. Some even borrowed to invest in equity! A proper asset allocation, periodic review and rebalancing & tweaking the asset allocation itself, to reflect the changes in one’s situation, are necessary.

Keeping expenses in check Amar had one golden rule. Keep your lifestyle a couple of notches below what you can afford. His favourite rule was if you can afford a Honda City, stay with i20. This way, one will be able to comfortably afford it and the running expenses as well as other expenses would not pose problems. He had been practising this in all facets of life. Most people do precisely the opposite. They buy a 3BHK home, when all they can comfortably afford is a 1 BHK home. These things that put pressure on one’s finances and compromises the future.

Keeping a budget and recording his expenses was the other important activity, which Amar practised to keep his expenses in check. Estimating the expenses correctly is the first step. For that, one needs to record the actual expenses incurred for a few months to get a hang of the pattern. Making the family members to adhere to the expense budget, is an important step in keeping the expenses in check. Amar used to reward them if they used to stick to their budgets. For his wife, he used to buy some jewellery and for his children, it used to be a trip to an amusement park.

Liquidity & contingency – Amar always used to keep sufficient liquidity. He used to maintain about two months expenses in his bank account for liquidity. Another two months liquidity was parked in liquid funds for getting somewhat better returns. He also used to maintain a contingency fund of Rs.2.5 Lakhs to take care of any unforeseen emergency.

Also, he had sufficient medical cover for the family, which is very important today. Without it, one’s savings can get depleted and expose one to an uncertain financial future. This can put various goals that one has planned for, in jeopardy. Since Amar had realised this early on, his family was adequately covered and he never had to pay for the medical emergencies in his family. This he had parked in bank FDs.

On hearing Amar spout such wisdom, Parth was floored. Parth ruefully thought that it might have been so useful had he asked the same questions two decades back. Now Amar had raced past Parth, inspite of Parth’s higher earnings and is looking forward to a peaceful and contented retirement. Parth had adopted a fancy lifestyle, overstretched himself in his home and his children’s education and is now looking to work for another five years. Two very different outcomes, just due to the way they handled their money.

The simple principles adopted by Amar had proved to be a major factor in his being financially solvent and achieve all his goals without compromises. 

Article by Suresh Sadagopan, Ladder7 Financial Advisories; Published in Business Standard on 5/7/2012

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