Personal Finance Management

For many people, personal finances work on elementary logic; money comes and goes. For some, the language used in the industry did not work well, and for the remaining, well, they have been good at managing their finances. However, we think it is not the best way to reach your short- and long-term financial goals. Let's begin with a four-step approach to helping you improve your finances.

1. Doing the math: Net Worth

You might hate mathematics, but we will have to ask you to start with some number crunching to help you evaluate your current financial health and plan the future. Start with comparing what you own and what you owe. In financial terms, evaluate your net worth. If you are not sure how to go about it, start by listing down your assets, which is what you own, and your liabilities, which is what you owe. Then subtract the liabilities from the assets. The number that you reach at the end is your net worth. Now, remember to reassess your net worth quarterly. Tracking it over time will help you identify your finances' winning and losing areas.

2. Planning your budget

Once you have identified areas requiring improvement, start planning your budget, a spending plan. It will not only help you spend wisely but reduce and eliminate expenses, plan for emergencies, and save for the future. We believe projecting your income and expenses for one month is the most straightforward and most efficient approach among all other methods. In doing so:

1. Start with your in-hand salary after taxes. This is the amount credited to your account every month. If you are a business owner, use the average monthly income you generate for yourself and deduct income tax.

2. Separate 10% income for a recurring deposit and another 10% for investment in stocks, mutual funds, ETFs, and the national pension scheme (NPS). Securing investments in a recurring deposit can hedge your risk in the stock market or related investment.

3. NPS is a tax saving instrument under section 80CCD (1) with a tax savings of up to INR 50,000 per annum. A salaried individual can save 10% of the basic salary plus dearness allowance (DA), and a self-employed individual can save 20% of the total gross income capped at INR 150,000 per annum. Once you have calculated the amount invest in NPS I and NPS II, in the ratio of 3:1. You will get the invested amount as an income tax return.

4. Separate the amount payable in necessary expenditures like housing, maid, food, and groceries.

5. From the remaining amount, separate 10-15% for health insurance and another 10-15% for term insurance. We will discuss the two insurance classes in a later article.

Once you've made these projections, subtract the amount from your income. The surplus, if any, is at your disposal to spend, save, or invest. In case you feel the amount at disposal is less, remember that at the end of the year, you will have up to INR 50,000 that you saved in taxes through NPS, put off unnecessary or significant expenditures until the amount is credited to your account.

3. Evaluating lifestyle, income, needs and wants

As the third step, recognize your lifestyle and manage your lifestyle inflation. It is not uncommon to match your friends' or co-workers' spending habits, but the difference is in how much you earn and short and long-term savings goals. You might want to increase your spending with an increasing salary; however, it is best to continue with the 5-step approach in identifying areas requiring improvements. In parallel, determine what you need versus what you want, unless you have an unlimited amount of money.

Needs are the things you need to survive like food, home, healthcare, and clothing. In contrast, wants are good to have things that are not necessary for survival. In the initial years of your career, needs should prioritize wants. Once your needs are met, allocate the discretionary amount towards your wants, it is best to use your income tax returns from planning your budget.

4. Building an emergency fund

You will not always land up in the best situations, and some of these at times will require a vast sum of money to solve the challenge. From where does this money come? It could be a part of your savings or investments. Frankly, going around this is a bit tough. You could either divide your RD investments into general and emergency funds, or you could set up a fixed deposit for it. But where does the money come for a fixed deposit? Well, most of us earn year-end bonuses, setting off 25% from it will not be difficult, and if you don't get this bonus, you could separate a part of your disposable income calculated in the personal budget.

Managing personal finances is not difficult. Primarily, we don't dedicate enough time to it and use all the money. It requires a lot of calculations, but none of it is difficult. It might look like a tedious task in the initial years, given you have a low salary, high education debt, or any other liabilities you plan on paying off at the earliest. You might not even have enough disposable income and might have to wade through the month with a minuscule amount. But remember, post a few initial years, at most three years, you will have sizeable savings, investment, an emergency fund, and you will have saved a whole lot of money from the income tax payable.

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