Personal Finances 101
Only 24% of Indian population is financially literate. Personal finance is not a part of school education in India due to which we don’t know how to make money out of money. When it comes to managing personal finance, our youth tends to procrastinate thinking that they have enough time but here they miss the power of compounding. According to Albert Einstein, compound interest is the eighth wonder of the world. We live in an era where we are seeking for instant gratification. But the results of compounding can only be seen after years of patience and perseverance. There is an urgent need to educate masses about finance and investments. This is an attempt to give an overview of the personal finance from Indian perspective.
1. Emergency Fund:
The first step towards financial planning is saving for an emergency. What if you suddenly lose your job or you meet an accident which makes you non functional for some months or if you want to take a break from your current job and enroll in some other short course. In all these situations, when you won’t be earning still you will have your expenses. In order to maintain your lifestyle during these emergency situations, you should have an amount of money which is you can use immediately.
For example, during this COVID pandemic a large number of people lost their jobs. We also know how difficult it is to get new jobs in this COVID situation. The individuals who would have already invested in emergency fund will be finding it bit easier to go through these tough times.
There is no golden rule but you should have 6 months of your expenses in your emergency fund. Liquidity and capital safety should be the highest priority in emergency funds and not the returns. Any safe investment instrument which can give you a return of 4–8% is good to go. Savings account, liquid debt funds, fixed deposits are the investment options which can be allocated towards saving emergency fund. The percentage of allocation in each can be decided by an individual.
2. Term Insurance:
After saving for emergency, the next step is to cover the risk of your life, that is, a term insurance policy. In case you are a sole breadwinner in your family this should be on the top of your priority list. If the breadwinner of a family dies suddenly, the family lose its source of income. A term insurance is a must for someone who want to save his/her family from a financial crisis in case of his/her absence. It is a best way to cover your life risk as the premium to be paid is very low but the sum assured is good enough for the survival of your family for a long time. If you survive during the policy term, you won’ t get any money.
As a general rule of thumb, you can get the sum assured 20 times your annual salary. It is advisable to buy term insurance as soon as you start earning because the younger you are lesser is the premium. For example, if you have annual salary of 5 Lakhs, you can get term insurance of 1crore as the assured sum.
Many people get into the trap of policy agents who offer them a cover of, say, 10 Lakhs with the same premium as 1crore but will have something in return if the policy holder survive during the policy term. Don’t get into this trap. Term insurance is not an investment tool, it is to cover the risk of your life. Buy a pure term insurance plan. While buying a term insurance, look for the claim settlement ratio percentage, higher the better. There are many add-ons also available while buying the term insurance, choose one according to your needs. If your job involves a heavy daily commute by road, you can opt for accidental rider.
3. Health Insurance:
While the life expectancy has increased significantly in the past two decades, the cost of medical treatment has also increased manifolds. The rising costs of healthcare services can burn a hole in your pocket. To prepare yourself for a medical emergency in advance, buy a health insurance policy. In this also, the earlier you buy a policy lesser will be the premium. The policy holder pays premium for the sum insured.
Health insurance policy is a contract between the policy holder and the policy provider. In case of medical situation, the insurance company pays policy holder for the medical expenses incurred. In this case too, find the policy provider which has a wide network of hospitals and have a high claim settlement ratio. Before buying the policy, properly enquire about the waiting period, diseases which are not covered in the policy, bonus offered for the years in which the policy is not claimed, etc.
4. Pay your loans
The next step is to settle all your loans as soon as possible. If you have multiple loans, start with paying the loan which has highest rate of interest. Use your credit card smartly. The rate of interest on credit cards loans is very high. If you have any credit card loans, try to get rid of it at the earliest.
5. Investing:
Next step is to use your money to make more money. The earlier you start, the more wealth you can create, it is the power of compounding. The best way to learn about investing is by actually doing it rather than just reading about it. Start with a small amount. First of all, figure out your risk appetite and then start according to that. Risk appetite of an individual determines how the capital should be allocated across different asset classes. Younger investors are usually considered to take more risk. Since they have more working years ahead of them, they can afford to lose more money. They can always earn it back. Older investors have other serious financial commitments like planning for their retirement. Hence, they aim at preserving capital rather than taking high risks.
If you have a high risk appetite, allocation to equity should be more. The ones with low risk appetite can invest in debt instruments. These days its very easy to start investing in mutual funds and stocks with the help of applications like Groww, Paytm Money, etc. The safest way to invest is to invest in the Index funds which can give you returns 4–5% more than the inflation rate in the long run. Investment is about patience, put your money and review it regularly. Don’t believe in the advice given by others. Keep your sentiments aside while investing. Start investing.
