Money goals: save, invest, insure, or borrow
Anew year offers a fresh start. It’s also a good time to evaluate your personal finances, taking stock of where you are and where you want to go from here. When it comes to money management, every person has his or her own unique needs. They must save, invest, insure, or borrow according to their life’s situation. Whatever be the situation, it’s advisable to benchmark one’s progress. This will ascertain if the bare minimum is being achieved at the very least.
In this regard, it’s often useful to have a rule of thumb guiding you in the general direction of your goal. By definition, thumb rules can be inexact. They are broad principles with arbitrary standards. One must understand the importance of the principle and tune the standards to your life’s situation. Here are some thumb rules you can apply to your financial life.
This rule is a ratio indicating how much of your disposable income you should allocate towards needs, wants, and savings. According to the rule, 50 per cent of your income should go towards basic needs such as rent, EMIs, insurance, food, utilities, transportation etc. Another 30 per cent should go towards discretionary spends: eating out, shopping, travel, and so on. And, at least 20 per cent should go towards savings and investments necessary for emergencies and wealth creation.
My suggestion is to swap the allocations for 30 per cent and 20 per cent — that is, make fewer discretionary spends, and save and invest at least 30 per cent. The more you save, the more headway you’ll make towards achieving your financial goals. These are broad budgeting strokes and you must find the ratio perfect for your life.
This is quite simple and a useful rule for conservative investors. The Public Provident Fund is a government-backed small savings scheme that allows you to invest up to Rs 1.5 lakh a year and earn 7.1 per cent per annum, tax-free and risk-free. Therefore, it serves as a useful benchmark for long-term debt investments, especially at a time interest rates are falling and we’ve gone through a period of great volatility in the investment markets.
If you’re going to be a long-term debt investor, it’s worthwhile asking if your preferred option is going to deliver post-tax returns at least equal to PPF. If it doesn’t, why are you buying it?
Everyone needs an emergency fund — the rainy-day purse to dip into during events such as job loss, health problems, urgent travel or immediate repairs. It’s your savings you do not touch under any other circumstance.
Every person has their own unique needs and responsibilities. For starters, it would be good to create a fund that is at least three times your disposable monthly income, and then gradually work towards six. As savings through bank accounts or fixed deposits provide low returns, it wouldn’t be sensible to lock away a lot of money in them as it would slow down wealth creation. But it’s not uncommon to see people save 12-24x, too.
Credit utilisation ratio (CUR) is the percentage of your available credit you’re using at any point. For example, if your credit card limit is Rs 1 lakh, and you’ve spent Rs 50,000 in a month, your CUR is going to be 50 per cent. It’s widely advised to remain under 30 per cent. This is because a high CUR reflects credit-hungriness, which leads to a fall in your credit score, which in turn would lead to difficulties getting fresh credit either through rejection of your application or having to pay higher interest rates.
Pay off your dues in the interest-free period every month. The higher your CUR, the more your credit score could fall. Also, do a monthly check of your credit report to understand how your credit card use shapes your credit score. If your score has fallen below 750, you could take corrective steps.
If you have financial dependants such as spouse, children or parents, you must own adequate life coverage. In the unfortunate event of your untimely demise, the coverage will replace your income and help your dependents continue with their lives without financial stress.
No two people have the same life risks, liabilities and responsibilities. But a simple thumb rule is having a life cover equal to 10-20 times your annual income, net of liabilities such as home loans. For example, if your annual income is Rs 10 lakh and you had a home loan balance of Rs 30 lakh, your coverage could be Rs 1.30 crore to Rs 2.30 crore. This coverage would make it possible for your dependants to meet their income needs for the foreseeable future.
Thumb rules are just the starting point of money management plans. They force you to devise solutions to your unique financial challenges. The key is not doing too little or too much but finding the perfect balance in things.
The writer is CEO, BankBazaar.com