Planning in Practice

Saving Regularly

Cash flows are made up of two components – regular income that will stop if we do not continue working and income from investments which continue irrespective of whether we work or not. Financial planning gurus suggest that if we aim to increase the second stream of income, it will make our lives secure and give us time to do what we actually enjoy. The best way to ensure that our investments increase steadily over the years is to start investing early and make sure that investments are given a priority.

In the days gone by, people used to spend money on various household and other requirements and save whatever was left. Then, they would wait till the money that was saved every month reached a “good enough” amount. They would take that amount and save it in the most attractive investment product available at that time.

But now financial experts have come to the conclusion that we must first set aside a fixed amount of savings. These savings must be immediately invested as per a plan. This plan must be created on the basis of our short term and long term goals. Then we can spend whatever we are left with, which is usually around 70-80% of our regular income. This puts your goals as your priority and ensures that you spend in a disciplined manner.

Emergency fund

Creating an emergency fund is quite similar to setting a goal and collecting money to fulfil it. The only difference here is that you hope the money will never be used for an emergency. The steps in creating an emergency fund are similar to goal setting.

• You have to on all the possible emergencies that could arise in your family. To do this, sit down with your family and ask for suggestions. All of you may come up with ideas such as – someone falls sick and has to be hospitalised, the family vehicle may meet with an accident and need repairs, very close relatives require a loan, extended family members drop in and have to be treated specially...and in the worst case scenario, an earning member of the family expires suddenly.
• Now put a price tag to each of the emergencies. How much money would you need if someone falls sick and has to be hospitalised, and how much would you need if unexpected guests drop in...and so on
• Now delete all the emergencies that have already provided for through health insurance, life insurance, general insurance.
• Add up the costs of all the emergencies that are remaining.
• Now, you don’t need to set up an emergency fund that equals the total cost of all the remaining emergencies. A sum of 30-40% of that amount should be adequate because it is unlikely that all the emergencies will strike at once.
• Now that you have a figure for your emergency fund, choose a financial product to invest in. Make sure that it will give you back your money IMMEDIATELY. After all, that is the whole purpose of collecting an emergency fund.

Managing debt

Traditionally, in India, being in debt is something which is considered bad. But things are changing now, with more formal lending institutions such as banks offering credit cards and loans for every reason. The repayment terms too are attractive...they allow you to pay back in small amounts every month. This has resulted in a change in spending patterns. Previously, people would save up money, collect enough to buy an item and then buy it. Now people buy things in the present and pay for them with future income. This results in debt of various kinds – credit card debt, short term debt, long term debt. But debt is still something that we should be careful of or it can lead to a debt crisis – a situation in which you have to borrow to pay back debt. Here are some tips to help you avoid such a situation:

• Don’t borrow unless it is necessary. If you can save and buy a fancy new television two years from now, do that. Continue using your old television for two years more. However, if you feel buying a tractor today will make a big difference to your output, by all means take a loan and buy it.
• If you own a credit card, try to pay off the monthly due amount every month. Don’t carry the balance to the next month unless you really can’t help it. Credit card balances attract one of the highest rates of interest within the banking sector.
• The rule to maintain while borrowing is that you and your family should ensure that all your loans do not amount to more than 1 and a half year’s income. Also ensure that all your payments towards your loan (interest and repayment) do not amount to more than 40% of your monthly income.

Of course these are outer limits and you should try to stay well within them. The best precaution would be to save for your goals instead of buying them on loans.

Dealing with a debt crisis

Quite often, a family can be burdened with loans that remain unpaid from year to year. The interest on such loans keeps increasing, despite the family’s efforts to repay them. At such times, budgeting for the loan should become the focus of a family budget. Here are some steps that can be followed:

• Transfer your debt to a lender who charges a lower rate of interest:  Sometimes, as in the case of Arvindbhai, people borrow from money lenders, who charge a very high rate of interest. When they are unable to pay back the amount with interest, within the specified period, the period is extended. But with increase in tenure, you also end up paying a much larger amount as interest. The family keeps struggling to pay off the interest component and never manages to pay off the actual loan. In such cases, you must find out if a micro-finance institution or bank in your neighbourhood is ready to give you a loan that equals what you owe the money lender. Even if they are willing to give you part of the amount, you will be partially free of the moneylender’s loan. The rate of interest to be paid to the micro-finance institution is comparatively lower. It will become easier for you to pay off your loans.
• Pay off your higher interest loans first: If you are not able to pay all your loans back at the same time, pay off those which have a higher rate of interest on them. This will reduce the overall amount that you have to pay.
• Make a very strict budget for yourself and your family: Nobody likes to live with loans. Try to first pay out at least 30 per cent of your income towards repaying your loans, or more if possible. Then, use the rest on your household expenses. Within household expenses, list out those that are necessary (food and education, etc.) and those that you and your family can do without, such as entertainment and spending on festivals and guests. Then try to do without the latter until your loans are paid off.

Insurance and protection

• Let’s suppose you plan for your goals and invest in various long and short term financial products. Let’s also say that all’s going as per your plans and you are contributing to these products as per your financial schedule. What happens if you are suddenly not around anymore to ensure that the money keeps flowing into these products? Should the dreams that you had for your loved ones suddenly disappear? Certainly not. If you have purchased adequate insurance, it will ensure that your loved ones continue to live the dreams that you planned for them.
• Insurance is a very important foundation which all earning members of a family must have before they invest elsewhere. It is the only product that will compensate a family with a pre-determined amount of money, for the economic loss of the earning individual.
• But how should one calculate how much insurance is enough? It all depends on how your current financial status is and what you would like to leave for your family.
• For example, suppose you have a loan of Rs. 3 lakh outstanding. This should definitely be covered by your insurance. Also let’s say your average monthly expenditure on household items, fees, maintenance and repair, etc, is Rs. 10,000. Assume that you would like to provide for your family for the next 4 years because after that they will be able to make alternative arrangements – your son will start working or your wife may take up a job. So, your insurance amount should include Rs. 4,80,000 to meet their monthly expenses for 4 years. Suppose you already have saved Rs. 2 lakh and you feel your family can use that money to meet their monthly expenses, you can reduce the insurance money by Rs. 2 lakh. In this very simple example, you would need insurance with a sum assured of Rs. 2,80,000. In real life, you would need to examine your family’s needs – include all your goals for them – and your existing financial products more carefully. This will help you to reach a decision on how much insurance you will need.

Source: Portal Content Team