The feeling of getting the first salary in your hand or seeing it credited to your bank account is awesome.
When you have something and you don’t know how to use it, it becomes a disaster. Unfortunately how one should manage money and basics of personal finance is not taught in schools. Students are taught about concepts and subjects which has no relevance in practical life.
I am going to provide to all basics of personal finance, which your school should have provided you. Anyway, I will do that for you.
(At the end of this article, I have presented an Action oriented practical formula to achieve better financial life based on these tips)
Understand your responsibility
Get conscious of how you are using your money. Youngsters generally spend and spend until they can know that they are left with nothing.
Understand your responsibility and no one is going to do that on your behalf. If you want to enjoy your relationship with money, you need to have respect towards it and spend it wisely. Respect the money and your work, that would be the foremost thing you can do before understanding basics of personal finance. You should enjoy the work before you enjoy the money.
Love your job but don’t love your company, because you may not know when your company stops loving you.Dr. APJ Abdul Kalam
Pay Yourself First
Save for yourself first.
Saving should be your #1 priority.
After getting salary, they incur all expenses and rarely save handful of money.
When you receive your paycheck, keeping some money aside should be your 1st goal.
I will discuss later what to do with your savings.
From now you should follow this order:
I know it becomes difficult to save every time.
If you don’t save now, you are having a huge opportunity cost.
Habits you develop in young age will stay with you long. Keep money aside or invest it when you get your monthly income. So you won’t get time to spend somewhere else.
Paying yourself first means keeping money aside for your goals, dreams, and retirement first, which will compound and give you surprise after 20-30 years.
How much should you save?
The Money rule
There’s a famous 50/30/20 rule of money.
As per this rule,
50% of your income should be spent towards your needs.
Here, needs may include your grocery bills, rent, various EMI, insurance premium, other house expenses. In short, it includes expenses necessary for your life.
30% of your income should be spent towards your wants.
This category includes your want and expenses which can be avoided. It may include dining out, clothing etc.
20% should be spent towards saving for future. Here saving maybe for retirement, achieving your goal, building emergency fund.
If your income is 50,000.
25000 should be spent on necessary expenses.
15000 towards your wants and 10000 should be your savings.
Here, we can debate on deciding which expense can be kept in wants and needs.
But rather than going in such debate, try to understand the intention behind such rule.
It only suggests that you should know how much you are spending on your needs and wants. If you understand it properly and twist it little as per your situation, it can do wonders for you.
The mistake people make is, they go with exact numbers and fail to achieve this.
It is ok if you are not able to achieve accuracy and exact figures while making a budget. If anyone does it, still it does not matter. Even I don’t suggest to do with accuracy.
Don’t complicate your life too much, with all this rules. Live your life fully.
You should have your own idea that this much amount I should use towards this needs, wants, eating out etc
When you start earning, have a goal of saving at least 10% of your net income, this is must. Then slowly you should move to 20%, 30%, and even 60%. (Yes, that’s possible with the help of passive income, continue reading to know more)
Know your personal net worth (Current position)
Before going anywhere, you must know where you are at present. Before you start thinking about investing your money, you should have a clear idea about where you stand now in terms of your financial position.
You should prepare your Personal net worth statement. which would describe your total assets and total liability and most important, your net worth.
If you fill this table, you would know how much excess of asset you have over your liability.
You must have listened people taking side of net worth over income. That’s really true. If you have more income but you are not working on building assets, you won’t have anything in the future.
Build emergency fund
Try to remember a day when you were in urgent need of money like urgent medical treatment and you didn’t get it.
had to ask for money from people you shouldn’t.
Did you feel disappointed?
If yes then you should think about an Emergency Fund.
If you didn’t face this kind of situation then you are lucky, learn from others experience and start building Emergency fund.
Emergency fund means money kept aside to deal with the urgent situation. It can finance your urgent need just like short term loan
Most people think they don’t need an emergency fund or they’ll manage somehow.
But believe me, when you face such situation you won’t be able to manage.
It’s just like insurance, you would know the benefit of it only when you need it.
Let me give a real-life example.
One of my relative was urgently admitted to hospital and surgery was required. As surgery was on the same day, cashless insurance claim would also take time, so money was needed to be deposited.
Although he had cashless insurance, still he was not able to use that because insurance claim would take 3 to 4 hour to pass and surgery was required to be done immediately.
Here an emergency fund can help you a lot.
Still, why most people don’t have an emergency fund?
– Build it and use somewhere else
– Have an undisciplined approach towards saving
How much to save for Emergency fund?
According to financial advisors, you should have 3 to 6 month of your net income.
But that’s just thumb-rule i.e. according to general principles.
So what suits you?
Calculate all expenses which you incur on monthly basis considering your EMI, insurance premium, rent etc..
No one knows better than you!
Only you know that by how much money your home and other expenses can be fulfilled. ( Expense criteria is more appropriate than income criteria.)
So as you know expenses required monthly, the question is about to build an emergency fund for how many months?
Experts say that if you are a businessman then you should have 6 months of expenses set aside. If you are doing a job then it is 3 months.
This is not something where you can say that this amount is perfect.
So you need to decide by yourself what amount you need to build.
Where should you invest?
A place from where you can withdraw it easily, without any extra cost incurred to withdraw it and most important, immediately.
Best place I suggest is to go with FD and keeping some amount in liquid fund from where you can withdraw within a day.
Having adequate insurance
95% of people in India are under insured.
Are you one of them?
You should buy insurance even before investing your money.
Still 95% people don’t understand about it and stay underinsured.
So, what are the reasons people stay underinsured or make mistake while buying insurance?
Buying insurance as an Investment.
Buying insurance for tax saving at end of financial year.
Buying random insurance on advice of agent.
Most insurance agents who run behind you to sell policy are selfish and will sell you wrong insurance.
I have seen people buying wrong insurance product and when they realise it, they don’t even close it because their close relative has sold that policy.
As per moneycontrol
Term insurance plan is a form of life cover, it provides coverage for a defined period of time, and if the insured expires during the term of the policy then death benefit is payable to the nominee.
Having term insurance is utmost important in your life.
It is better than other insurance policy as it does not involve any investment component in it. All other policy except medical insurance and whole life insurance will benefit insurance company and agent.
Let me elaborate it with an example.
Suppose, if you take term insurance of 1 crore, you need to pay 25000 premium annually and in case of death(May you live long), in such situation your dependent(nominee) will get 1crore.
You should have medical insurance so that in case of any hospitalization your family should not suffer financially.
If you have good medical insurance, it will also compliment your emergency fund too.
I will write an in-depth article on insurance soon.
Stay away from the trap of debt
Debt is not bad, it can be very helpful for tax purpose. But people have taken statement too seriously and have a huge load of debt.
Loans and credit cards can be your best friend but it has become our enemy. Thanks to the education system who didn’t even teach us the basics of it.
The moment we start earning, we start purchasing things we don’t need and even it is out of the budget. Soon we realize that we are having a huge load of debt and don’t know what to do, except paying it and wait until it gets over.
There’s a concept called good debt and bad debt.
It means taking a loan on appreciating asset which will generate the return. If such asset is purchased then, the loan can be paid with help of return generated.
Appreciating assets include real estate, specifically commercial property and not apartments or flats, because housing property does not generate enough return to pay your debt and you won’t have a surplus. Commercial property has more appreciation if purchased on right time and in the right place.
It means taking a loan on depreciating asset. Depreciating asset means an asset which will not generate a return for you but it will take more cash flow out of your pocket in form of maintenance exp etc.
It includes purchase of a car, AC etc.
No doubt these items are necessary for life, but purchasing it by taking burden of loan is obviously not a good idea. You can purchase such items with help of goal-based investing, which I have discussed in later part of this article.
Start investing as early as possible.
Suppose you are saving only 5000 a month and it is invested @12% CAGR for the period of 30 years and you delay your investment only by 1 year, you are losing 17,00,000.
That’s huge right?
Now, you will take investing early seriously.
When you have just started earning make habit of saving and investing, which will help you in long-term.
The habit you develop now will influence your future.
Goal-based investing means investing for purpose of achieving some goal in future.
If you want car after 2 year and invest keeping in mind goal of purchasing a car, its goal-based investing.
Goal-based investing helps in the following way:
Your risk is reduced.
Now, you will not invest for getting a return but rather achieving a goal.
You will not be greedy
Your goal may be like:
-Investing for buying a car
-Building retirement corpus
-Building children education fund
-Saving for marriage.
It’s easier and simpler than you think.
Suppose you have a goal to achieve In next 3 year. You can invest in equity and debt proportionally.
You can use the financial calculator available to know about how much monthly investment would be required to get that goal achieved and start Investing until the goal is achieved.
Learn about income tax
Having basic knowledge of tax you are paying is very important
It’s not always ok, to be dependent on your C.A. or tax consultant.
I don’t say you to know each and every section of income tax act 1962.
But you must know how your salary is taxed.
But having basics clear about slab rate, section applicable to you, ways you can save tax can help you to manage your personal finance in your own way.
Using Credit card
A credit card can be your best friend. You should it wisely.
When you start earning, it would be normal for you to get a call from a different agency to get a credit card.
Using a Credit card as per your need can help you well.
Don’t delay payment, pay a full amount monthly or bi-monthly, as per terms.
This would impact your credit score in a positive way.
Work on your CIBIL score.
Don’t ever do any act, which can impact your cibil score negatively like not paying credit card due amount, delay in payment of EMI.
If you have a good CIBIL score, you can get a loan at a cheaper rate. Work on CIBIL Score at a young age, which helps you in the future.
Start building another source of income
You should not be totally dependent on your salary. Doing such act can put you in serious trouble sometimes.
Start working on developing a skill which can help you to earn handsome money side by side.
In the era of internet when everything is on the internet, it’s better to develop a skill and earn online.
The Internet is having huge potential, don’t underestimate it. It is very useful to create another source of income when you already have a full-time job.
You may work as:
-Consultant providing your service
-Start a blog and earn by selling courses, ebook, affiliate marketing.
Some financial rule of thumbs
Rule of 72.
As per this rule, if you divide the annual return of any financial product by 72, you will get to know how many years will it take to double your money.
Don’t get too surprise, 72 doesn’t have any magic.
If you use compound interest formula and keep interest same as principal and simplify it to the extent possible, you get number around 72. That means it’s just a simplification of formula.
Asset Allocation rule
This rule suggests 120 (-) your age, the percentage derived should be invested in equity.
For example, your age is 30, so as per rule,
120-30= 90% should be invested in equity and 10% in bonds, debenture etc.
(Old rule of thumb was 100, but I find 120 to be more appropriate)
Again, this shouldn’t be taken for granted, your goal for Investing should be your priority.
Once you have basics clear, you can plan managing your money in your own way. Here I have provided practical steps you can take if you are just starting out.
#Step1: Build emergency fund. Have atleast 3 to 6 months of your expense in your bank account to face urgent situation.
#Step:2 Buy term insurance and medical insurance.
#Step3: Once you have emergency fund, define your long-term and short-term goal and start investing.
#Step4: If you have any type of loan or credit card, automate its payments so you don’t have to worry about it and your CIBIL score can be improved.
#Step5: Plan your taxes and learn how to save tax legally.
#Step6: Start building another source of income.