After all, in today's world you don't only have to make a lot more choices and financial decisions compared to earlier times, but also have to keep track of more details – ranging from credit card dues to various loan and bank accounts, and from stock market investments to health and retirement plans.
Human life has a tendency to get complicated, and this can happen with your finances too. After all, in today’s world you don’t only have to make a lot more choices and financial decisions compared to earlier times, but also have to keep track of more details – ranging from credit card dues to various loan and bank accounts, and from stock market investments to health and retirement plans.
Therefore, learning how to winnow down your choices and streamline your finances is as much important as increasing and diversifying your portfolio. Planning your financial future can often seem daunting, but it doesn’t have to be that way. You can simplify your finances and financial life by beginning with these 10 steps:
1. Set clear financial goals
This is the first step towards being on top of your finances. Although it might seem like a simple task, most of us do not set clear financial goals. A clear financial goal includes a time and objective. For example, your financial goal might be “I want to save Rs 5 lakh by June of 2018 to purchase a car.”
“It’s also important to be aware of all your financial goals and include them all. For example, many of us do not think about retirement as a financial goal. By listing it down, it forces us to re-think the situation and do the research to come up with the time and objective,” says Raghu Kumar, Director, Upstox.
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2. Learn the basics
Let’s admit it: there are probably things you can learn today to improve your finances. The problem is that when it comes to finances, it becomes easy for us to procrastinate and set it aside.
Contrary to what most people think, you do not need to be an expert in order to be on top of your finances. But you do need to know all the basic terminology in order to be able to make the right decisions. A few examples include: understanding the difference between stocks and bonds, understanding how the stock market works, and how to read a balance sheet.
Start by reading a couple of books on the basics of investing and only move on once you feel that you have understood the basics.
3. Understand your financial situation
Each of us is in a different financial situation. Therefore, there is no cookie-cutter mathematical formula that can be used to optimize your investment decisions.
“In order to fully understand your unique financial situation, you need to go pull up all your financial information and be diligent about understanding it all. For example, what are your monthly expenses? How much of that is non-discretionary (fixed expenses that are required), and how much of that is on leisure? How are you investing your disposable income, and do you feel that you are being optimal?” says Kumar.
4. Set a monthly budget
Setting a budget is the perhaps the most important financial step you can take. A budget is the amount you are able to set aside for expenses, including savings. The budget can include:
a. How much to set aside monthly for retirement
b. How much to set aside monthly for long term expenses (a car, house, etc.)
c. How much to set aside monthly for short term and unexpected expenses (a family vacation, or replacing a lost item, etc.)
d. How much to set aside monthly for spending for pleasure (night out with family, or buying yourself an item, etc.)
In order to calculate your budget, you need to see what your expenses come out to. Simply go through your previous 6-12 months of expenses and categorize each expense. You can then see what your monthly expenses come out to. That’s your budget.
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5. Save and then spend; don’t spend and then save
This is perhaps the key element towards financial independence.
Most people don’t realize that when it comes to saving money, they usually end up spending and then saving. For example, how many of us, after receiving our monthly salary, set aside money for saving, and then spend our money on expenses? Most of us pay off our required expenses and use whatever is left over to save.
By switching the order, you are forcing yourself to save the allocated (budget) amount of money to save each month, thereby reinforcing a positive behaviour that cannot be changed. So it’s important to set aside money each month for saving and use the rest on spending/expenses.
6. Avoid fixed deposits
75% of household savings in India are invested into fixed deposits. Therefore, it would seem that fixed deposits are a good tool to use to generate interest.
But nothing could be further from the truth! While fixed deposits are usually marketed based on pre-tax returns, you need to look at post-tax returns to see why fixed deposits are usually not a good option.
“Most long-term fixed deposits generate up to 9% return on a pre-tax basis. So if you invest 1 lakh in a FD, you would earn Rs. 9000 in interest in one year. But you pay taxes on the interest earned!
Assuming you fall in the 30% tax bracket, you would pay Rs. 2700 in taxes. This means that you only earned Rs. 6300. Therefore, your return on investment is 6.3%. This barely beats the current inflation rate,” informs Kumar.
7. Understand all the investing tools that are available to you
There are many investing tools at your disposal. Most of us only look at fixed deposits, real estate, and perhaps gold as low-risk, high reward investment options. But the truth is that equity mutual funds, debt mutual funds, equities, bonds, and commodities – all are just some examples of alternative investment options that can provide you a great return on investment.
Visit your bank and speak to your Relationship Manager to ask about all these investment options. If your bank provides a 3-1 account, this should be relatively simple to do. Ask detailed questions to understand what your bank provides.
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8. Open a Demat account
Your first step towards the stock markets is to open a Demat, or dematerialized, account. A demat account will be required in order to invest in the stock markets.
“Before actually going in and investing in stocks, it’s a good idea to understand how to invest in stocks. In order to do that, you will need to open a Demat account. You will need to either go through your bank and open a Demat account there, or you can opt for a low cost broker that provides broking services online. Either way, it’s a very simple process that should not take more than 30 minutes or so,” says Kumar.
Spend a good amount of time before going ahead and selecting your broker. Look for a broker that has a solid reputation, is low cost, and provides powerful investing tools.
Diversification is incredibly important when it comes to investing. Never put all your eggs in one basket!
It’s important to look at investing as a method to maximize your profits while keeping risks at a minimum. Therefore, diversifying your investments into different asset classes is a good way to be hedge yourself. For example, by investing in debt mutual funds, you stay hedged against equities. This keeps your protected from a downturn in the stock markets.
The best rule of thumb with diversification is to maximize variety. Even if you are setting aside a small amount per month, try to set aside a lower amount per investment but maximize the number of investments.
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10. Allocate 15 minutes a day
It might not sound like much, but allocating 15 minutes a day helps to be on top of your finances. In one month, you would have spent 8 hours. That’s more than many of us do in an entire year!
By setting aside a fixed amount of minimum time daily, you will also be aware of the latest updates in the economy (you can set aside the time to read the business section in the newspaper). You will also feel more comfortable with your finances and your financial situation.