What they don’t teach at schools and universities– Personal finance

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People nowadays have many educational degrees and knowledge of all round the world, but one major aspect of life they lack is the personal finance department. Often ignored subject, personal finance could literally make or break your future. It is pity that a topic of such importance is not a part of the educational curricular. We may plan our income side the way we want, however if the expense side is overlooked, it may be futile to plan the income side any further. Increasing your income side may be the solution for many issues, but doing so along with managing your expenditure might do wonders for your future.

Controlling your expenses does not necessarily means to forego your standard of living, although it may make you sacrifice some of the unnecessary spending. To begin with, the first thumb rule in controlling your expenses is the rule of budgeting. Elizabeth Warren a Harvard Professor, first established a principle known as 50, 30, 20. This principle simply bifurcates your post tax income into needs, wants & savings in percentage of 50, 30 & 20, respectively.

In this principle, Warren, has specifically defined what is needs, wants & savings, thus allocating your funds in the most optimum fashion. Needs are nothing but stuff without which it will be impossible to live, eg: rent, house loan EMI, groceries bills, electricity, water etc. Whereas wants are something which are not necessary to survive, but are required to enhance your lifestyle, which may include dining out, travelling for leisure, exploring hobbies etc. Lastly savings, which like needs, should not be ignored, as it will design your future post retirement or even in case of any mishap, eg: Savings for house, retirement fund, child education etc.

Plan of action

Now since we know what budgeting is, it is important to know how to implement it, let us look at some steps which can be followed for the same:

Step 1: Check out the monthly salary that is being credited in your bank account.

Step 2: Multiply the salary by 0.50, 0.30 & 0.20 in order to ascertain the amount of needs, wants & Savings respectively that could be made from it.

Step 3: At the end of the month check your bank statement and categorise all your expenditure in the either need, want or savings.

Step 4: Stick to the plan.

Once you learn how to control and manage your expenditure, without getting too excited you should now plan for investing. Controlling your expenses is work half done, as investing is an equally important task in every personal finance scheme. Savings are done with a pre-determined objective in mind, and considering inflation, the cost of such objective is ever increasing. Purchasing power of money is falling every day, hence an objective that can be achieved today, may not be achievable tomorrow. Going by that principle, mere savings will not fulfill the end result of such savings, but investing them in proper instruments will certainly help.

Investment strategy

Investment could be categorized in long, medium and short term, depending upon the tenure of investment. From an economic principle perspective, the longer you stay invested, better the returns. Thus, rate of returns is directly proportionate to the tenure of investment. Every financial objective has an inherent time limit within which it needs to be achieved, for example for child education you may need the corpus at around 16-18 years from the birth of your child. Therefore, investing the money in long term instruments, such as mutual funds, Public Provident Fund, National Savings Certificates can be recommended. On the contrary if building an emergency fund is the objective, short term route with higher liquidity options must be preferred.

Apart from return, another important point which should be considered is tax saving. Usually all tax saving scheme are medium to short term investment, since they possess lock in period at the beginning of the investment itself. In addition to that Indian tax regime provides tax savings under different head with certain limitation. Therefore, it is not always that you can invest all your money in medium term tax saving scheme.

Lastly, another important factor in influencing the investment decision is the risk factor. Risk is determined by the probability of loss that may occur on account of loss of amount invested or lower returns compared to what was prescribed or assumed. Risk factor is higher in equity and equity linked instruments, whereas it is lower in debt or related instruments. On the contrary, high risk instrument tend to give higher returns compared to low risk instruments. Therefore, depending upon risk appetite, one can choose the appropriate instrument.

Budgeting and investing go hand in hand, since one is imperfect without the other. Therefore when you think of controlling your expense, you should also think of investing your money in right instruments.

(The writer is founder, Money Mantra. Views expressed are personal)