Personal finance. Hear that and we picture a complex web of taxes, fixed deposits, mutual funds, demat accounts and just a lot of confusion. We want to save money, invest and watch that money multiply but take a long time getting around to it. Maybe we don’t have enough money or make enough money. Maybe we just want to ‘live in the moment’ because all our lives, all our parents did was save. You know you will too, when the time comes, but it would help to know the nuts and bolts of it. So, ladies and gentlemen, welcome to our beginners’ guide to investing.
Anyway, personal finance.
Let’s start with the meaning of that phrase. Investopedia defines personal finance like this: It is the science of handling money. It involves all financial decisions and activities of an individual or household – the practices of earning, saving, investing and spending. Matters of personal finance include the purchasing of financial products, like credit cards, life and home insurance, mortgages and of course various investments and investment vehicles. Banking is also considered a part of personal finance, including checking and savings accounts and 21st century online or mobile payment services like.
Warren Buffet, the one man we think of when we hear the word investments, once said, “Someone’s sitting in the shade today because someone planted a tree a long time ago.” Wise words, those, from the probably the smartest, most no-nonsense investor in the world. The message is – be a forward thinker when it comes to personal finance. When deciding whether to put some more money aside for emergencies, think of a financial emergency actually happening and how much easier your life will be if you have enough money set aside.
Think of the trip you want to take to see the northern lights in Iceland or Norway. Or maybe you want to sail around the world. Or climb all the famous volcanoes. Or invest that $1 million in a government-approved scheme in America to get an EB-5 visa and get citizenship in less than 5 years. See? It could be a broad plan or very very granular. Each plan begins with the same caveat – save money and things can generally get better in life. Let’s discuss some basics of saving and investing.
The most important parts of personal finance that one needs to keep in mind are:
- Cash flow
- Savings and investment
- Retirement planning
But first, some Dos and Don’ts.
The most crucial thing is to plan your budget. All talk of assets, equity, mutual funds, hybrid schemes, etc etc, are just hot air until you draw up a budget, with specific numbers. A budget is a roadmap that allows you to live within your means, while having enough to save for long-term goals. Traditional wisdom recommends approaches like the 50/30/20 budgeting method. What that means is, 50% of your take-home pay or net income, after taxes, goes towards living essentials, like rent, utilities, groceries and transport. Another 30% for lifestyle expenses, such as dining out and shopping for clothes, etc. The remaining 20% is invested in your future: to pay debts and to save – for retirement as well as for emergencies. Of course, this changes depending on your comfort levels.
Now, with that in mind, remember to limit your debt. This is just common sense but a large number of people ignore this so it is always good to reiterate. Don’t spend more than you earn.
Of course, most people do borrow now and then. Sometimes going into debt can be advantageous, if it leads to accumulating an asset. Buying a house, for example. Otherwise, avoid borrowing. Especially using credit cards, which are debt traps. There are advantages to using credit cards but, in general, avoid maxing out credit cards at all costs, and pay your credit card bills strictly on time, every time. Paying bills late ruins your credit score.
The other important aspects, i.e. insurance, taxes, savings, investments, and retirement planning are what we will cover in detail in this Personal Finance series.
For those who are new to financial planning and investing, let’s count the types of asset classes that investment covers. Wait, what are asset classes? To understand that, let’s understand two terms – Assets and Securities.
Investopedia defines an Asset as a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Assets can be broadly categorized into short-term (or current) assets, fixed assets, financial investments and intangible assets.
A security is a tradable financial asset. The term commonly refers to any form of financial instrument. Securities are broadly divided into three categories:
- Debt securities
- Equity securities
Keeping these basics in mind, let’s look at asset classes. An asset class is a group of securities that exhibits similar characteristics and behavior in the marketplace and is subject to the same laws and regulations. Asset classes are of three types: equities, or stocks; fixed income, or bonds; and cash equivalents, or money market instruments. Some experts also include a fourth asset class – Real estate or other tangible assets.
These are what form your portfolio. Stocks are lumped together even though individual stocks—or even mutual funds—can be quite different.
Now that we know what a portfolio comprises, we need to dive deeper into the different working parts. What are stocks? What are mutual funds? What are my other options? Does any of this get simpler at any point?