11 February, 2014

What couples need to know about managing finances

Marriages are made in heaven, they say. It is certainly one of life’s most intimate relationships. Hence, it is natural to trust the partner implicitly and be a bit relaxed and laid back on many fronts, including finance. Trust is important in a marriage. And for that very reason, spouses don’t raise too many questions when one spouse takes financial decisions concerning money of the other.

All these should not pose problems normally. But, there are situations when it can. It is important to understand certain basics in marriage as regards money to protect the interests of both spouses. Also, money can become the rock on which the tender institution of marriage could break.

The risk tolerance of the spouses can differ :  This is an area which is overlooked, if there is a dominant spouse taking all financial decisions. Let us say the husband is someone looking for high returns & is willing to assume high risks in the process. Let us suppose that the wife is a very risk averse person. In this situation, if the husband takes all financial decisions according to his risk appetite, it will make the wife quite queasy, due to the high risks involved. This can cause friction between the couple, which could have been avoided if their individual risk appetites have been factored and then the investments were done.

The best way to handle this kind of situation is to invest one portion of the money as per the risk tolerance of the husband & the other as per the risk tolerance of the wife. For the plan to work, the asset allocation cannot afford to compromise on the correct allocation in growth, debt and other assets. The overall allocation should be such that the majority of the risk assets are with the husband and the predominant portion of the wife’s investments are in safe assets. Such an allocation would meet the overall requirements of the family as well as the aspirations/ fears of the parties concerned.

Spouses should bear expenses proportionately :  Many times we find that one of the spouses takes care of all expenses and the other does all investments. Sometimes, one of them pays all EMI and the other takes care of other expenses and investments. In these situations, the spouses are laying the ground for future discord as one person may feel he/she has only been spending and the other spouse has been able to make the investments.

This problem can get compounded in case of a discord in marital relationship. In fact, this can be a fertile ground for marital discord. What can be done?

In the interest of fairness, the family expenses should be borne in the same proportion as income they are earning. For instance, if the husband is earning Rs.1 Lakhs pm and the wife brings in Rs.50,000 pm, then two-thirds of the expenses should be borne by the husband and one-third by the wife as this is the same proportion in which they earn. After this, they should make investments from the surpluses left.

Joint accounts : Joint bank accounts are fine when it comes to expenses. Each spouse can transfer a predetermined amount into that account for expenses. But from an income tax point of view, it is better to maintain separate accounts from where the investments are made. This account can either be one’s salary account or an account into which the amounts to be invested is transferred.  This will ensure that investments and their sources are clearly demarcated.

It is better to show clean transfers to this account which will ensure that there are no problems with Income Tax department, if one were to explain the source of various investments. Also, it is a good practice to have the investments separate. Each spouse will have some investment and in the event of a dispute, this would prove to be really useful. Like they say in armed forces – Trust in God, but keep the power dry.

Investments : It is not that the investments cannot be made jointly… but the primary investor should be the first applicant and the spouse should be the second applicant. And like it has been mentioned before, it should be invested from an account which can clearly be mapped to the first applicant. All investments should be done in both the names; wherever that is not done, atleast the spouse should be the nominee.

Insurance :  Insurance would be required to protect the family, incase the income earner is no more. But many times the husband has insurance but the lady of the house does not have insurance or has insignificant sums. This will create problems, if at all there is a separation. In such an event, suppose the children are with the mother and the mother were to pass away without sufficient assets to back them up, it will be a problem. The insurance should ideally be a sufficient amount that could cover the expenses of children till they reach adulthood & can also take care of their goals like education.  Term insurance is inexpensive today and should be considered by spouses with dependents, especially if the marriage is going through a rocky patch.

Knowledge :  It is important to know where the money is being invested. Ladies do not show much interest in financial matters. Their spouses do investments on their behalf which means they are completely ceding control to their husbands, which could be dangerous especially if the relationship is turbulent and separation is a possibility. Women have to show more interest in their finances and need to understand where the investments are being done, whether they are being done in their names, if they are in the proper assets and instruments etc. For lot of women who have not paid attention to their finances, a separation comes as a rude financial shock as they are completely at sea regarding their investments.

Prudence should be the watchword for couples. Marriage is a relationship of trust. Trust your spouse; but be aware of what they are doing with your money. Involve a trusted advisor, where required. Have enough knowledge of the financial domain to be able to manage on your own, if you may need to do that. Review or get your portfolio reviewed, from time to time. That way providence will not find you wanting even when the going gets really rough!  

Athor : Suresh Sadagopan  ; published in Money control.com  ;  www.ladder7.co.in

10 February, 2014

Why you need to focus on your spending for your financial wellness?

A friend of mine was elated that he was saving Rs.25,000 a month.  He swelled with pride at being able to put aside a quarter of a lakh towards savings.  But somehow, when I ran the numbers to find if he can achieve his goals, they showed that he is woefully short of the amounts required.

It is infact true that Rs.25,000 savings per month is a good figure. But this has to be looked at within the context of what is needed for achieving the goals and fulfilling other needs. Also, one needs to look at the savings in the context of one’s expenses. 

Expansive Expenses are a problem :  In our practice, we find lots of cases where expenses are the undoing element in the plan.  Our client Vidyasagar, is a senior level manager in a multinational firm. He earns about Rs.2 Lakhs as income and he is indeed able to save about Rs.30,000 pm.  This means he is spending about Rs.1.7 Lakhs pm., which includes Rs.46,000 as EMI for his home and another Rs.7,000 as EMI for the car. This still means that he is spending Rs.1.17 Lakhs pm.

We found this to be high and went through various items of expenditure. We found the expenses in some items like entertainment & personal expenses to be pretty high at about Rs.10,000 each. On further discussion, it emerged that they do go out for dining, movies and on some weekends, they drive out to nearby places on a daylong picnic. Similarly, the personal expenses included his wife Bhanu’s parlour & her personal expenses as well as some personal expenses of Vidyasagar. We found some other items as well which were high, which were impacting the buildup of savings.

Normally, we do not overstep our limit when doing financial planning for our clients. Our philosophy has been that the clients should be allowed to lead the lives that they choose, rather than we standing in judgement on what they could do. But, we have found that in some cases expenses completely overwhelm future planning itself, cutting off the funds desperately needed for a well-funded future. It is in such cases that we point out the problems encountered in building the required corpus and get them to tone down their expenses, for their own sake. Incidentally, Vidyasagar was able to tighten the belt and release another Rs.15,000 towards savings.

The ratio that that mirrors your health :  Savings per se is not something that can be termed high or low.  Savings need to be seen in the context of one’s spends. Infact, even low level of savings can work if the expenses are in check. For instance someone spending Rs.40,000 a month and saving Rs.30,000 a month is actually doing quite well.  That is because the saving being done will cover 75% of the expenses for a month. In Vidyasagar’s case discussed before, his saving of Rs.30,000 can cover only 26% of expenses without EMI and under 18% of expenses including EMI. This measure shows the even though both are saving the same amount, the former is better off than Vidyasagar.

Savings to Expense ratio is hence a very important indicator of how well someone is managing their finances. A high ratio is good and would indicate that their savings are healthy enough.  But, the regular expenses may not pose problems for some, but the future goals can.

Some have pretty ambitious goals. For instance, some parents want a lavish wedding for their children which would be an expensive proposition. Goals are future expenses. If these future expenses are very high then the savings required in the run up to the goal will also be high. It is hence important to do a reality check on the future goals too and see if they are in line with what one can reasonably expect to save.

Spending Ignorance is not bliss :  Many do not really know what they are spending.  And that could be a big problem. Since they earn a good amount, they keep withdrawing money from time to time, till the money gets exhausted.  This problem needs to be tackled in two ways. Estimate the amount of savings required and put that away before starting to spend. That way even if they were to spend the entire balance amount, they would have done that only after putting aside the required savings amount.

The second aspect is to really seriously look at the expenses themselves. Unwittingly, one may be overspending in some areas. Only when they get down to it and calculate how much they are spending would they become aware of the problem. This knowledge is necessary to tailor the necessary course correction.

Havoc of Inflation :  The other problem faced by people today is inflation. Expenses are ballooning even though they are essentially consuming what they used to consume before.  Consumer Price index has been in double digits in three out of five years, since 2009. But investments have not kept pace. The investment returns post-tax, are lower than the inflation figures, which means that one needs to spend much more for the same value. This is even more reason to be aware about one’s expenses and see how to keep it in check.

It is important for people to hence first understand what they are spending, what they are spending on and whether it is possible to pare it down, what their future goals are and whether they are realistic & whether they are saving enough in relation to the expenses . Also, they need to understand the inflation monster and it’s pernicious effect on them. So, while planning ones finances expenses are an area which one needs to looked at carefully more than even savings – for that can make or mar one’s future. 

Author - Suresh Sadagopan  ;       A version of this was published in Business Standard on 9/2/14