Money management gets easy if you understand the thumb rules of personal finance. We need money to manage most areas of our day to day living and managing it well can have positive impact on our life. It is sad though that personal finance has been ignored; there is no formal education in the initial years of our life at school or college.
It is important that families discuss the role and importance of money among them and especially ensure that children understand its workings. Below are few thumb rules of personal finance that everyone should understand.
Thumb Rules of Personal Finance
Building wealth starts with savings
One of the most important thumb rules of personal finance is to spend sell than you earn. Without savings there cannot be any investment. You should ensure that your expenses are limited to 50% of your income in order to save and invest towards building wealth in the long run.
Start with your first pay check
Consistent savings however small can have a big impact. Even a ₹ 500 monthly investment to start with is good enough. Compounding works best with time and the longer you stay invested the better the results.
Don’t fall for lifestyle creep
Increase your savings and investment with increase in salary/income. Don’t fall for lifestyle creep, control your urge to splurge on luxury items. Limit your increase in spends to 10% of the increased income and try to save and invest 90% if the increment that you get.
Importance of Emergency Corpus
Start with creating an emergency corpus and build one that can take care of your basic expenses for 9 to 12 months. An emergency corpus is meant to save you from emergencies not generate extra returns. Do not risk this corpus by investing in risky instruments. Stick to Safety over Returns when it comes to emergency corpus.
Get the right Risk Mitigation Tools
Mitigate risk by getting adequate insurance. Ensure you have pure term life insurance to take care of your loved ones in your absence. Opt for 10 to 15 times of your annual income or get help from a planner to assess how much your family will require till your child is financial independent. Read here to know if you should insure or invest first.
Prepare for Medical Emergencies
Medical emergencies can strike anytime. Having adequate insurance will ensure that your emergency corpus is not exhausted. A 5–10 lakh of base cover with a ₹ 25 lakh top-up policy for you and your family will give you peaceful sleep. Opt for critical illness, disability and property insurance.
Understand and Manage Debt
The thumb rules of personal finances say that you need to understand the difference between good and bad EMI. Don’t fall for 0% EMI trap, the processing fee work out to around 14% interest cost. Your EMIs should not cross 25% of your net income which will ensure you have enough surplus to invest towards your goals and aspirations.
Prepare and Maintain a Budget
Prepare and maintain a monthly budget. There are plenty of online and excel based budgeting tools that will help to track your expenses. Differentiate between mandatory and discretionary spends. Read here to understand the 5 steps to build a budget.
Follow a Goals Based Investment Approach
Prioritize your goals and understand the various parameters that have an impact on them. For example, if you want your child to study outside your country, you will have to budget for tuition fee, living & travel expenses. There is also a possibility to apply for scholarships for tuition fee. Read here to understand the difference between Goals Based and Market Situations Investment Approach
Before you start investments it is important to understand your emotional behaviour to money and investments. Know you comfort level and understand that equities are very volatile instruments and can give you negative returns in the short run. If you can’t handle short term volatility seek help and construct your portfolio accordingly.
Undertake Risk Profile Assessment
Undergo a proper risk profile assessment to understand the ideal asset allocation for your goals. Know how much and in which instrument you should be investing. Fixed income instruments are suitable for short term periods and equities are best if you have an investment horizon of over 5 to 7 years.
Monitor/Review and Rebalance your investments at regular intervals
It common for your asset allocation to change over a period of time. For instance, you can set a rule that you will rebalance your portfolio if it deviates by more than 10% and bring it back to your ideal asset allocation. This ensures that the portfolio risk is aligned to your profile, goals and aspirations.
Implement these thumb rules of personal finance today. Wish you a successful journey !!!