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BASL Registration Number: 1951 | Non-Individual RIA. Regn No. INA000017620 | Validity Perpetual

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Basic tenets to achieve financial discipline

Financial problem usually is one of the prime stress factors for individuals today. This may be due to buying the wrong financial product, a huge debt pile-up, over spending, inadequate liquid funds during emergency, etc. Some simple and prudent personal finance habits can save a lot of time, money and trouble and help us achieve a better control over our overall finances.

Since last 7 years I had prominently displayed a list of dos and don’ts in financial matters in my office for all my visitors to see. The list basically chalks out general guidelines about how to stay financially disciplined. I would get appreciative comments from a lot of my clients who by the way also plead guilty to violating at least 2-3 of those personal finance tenets.

Here is the complete list discussed in detail below:

I will not keep my money idle in savings bank account:

It is important to make your hard earned money work harder for you. So it is crucial not only to deploy your savings for investment but also to select the right investment option. While the savings bank interest rates have been deregulated, they offer a meager 4-6 per cent returns per annum which do not even beat inflation. So it is prudent not to keep huge amount of cash idle in savings bank account.

The maximum amount in savings bank account should be for monthly household expenses and some funds earmarked for emergency situations. An emergency fund helps to sail through critical times like a medical emergency, loss of job, etc. While there is no thumb rule for the amount, funds equivalent to six months household expenses (including EMI and insurance premium) can be invested as contingency funds. Although savings account offer low returns, one advantage is that the interest earned will attract a tax rebate of Rs.10,000 per year as per the recent budget proposal. This means that you can keep a balance of approximately Rs.2 lakh in your savings account and actually profit from it. The balance savings can be deployed in comparatively better options.

I will not subscribe to public issues indiscriminately

I have never been a great fan of IPOs (initial public offer) although I am aware that people who invested through IPOs in 70s and 80s and even a large part of 90s have created wealth. My lack of enthusiasm is due to the fact that:

  1. Most IPOs are floated when markets are booming. As the popular saying goes, A rising tide raises all boats. Similarly, companies with new fund offers command hefty & unreasonable valuations in the booming stock market compared to their real worth and the upside for the investor is limited. Often, they trade below their initial offer price for a long time once the IPO hype fizzles out and the investors sell in desperation for a loss. E.g., Reliance Power IPO.

  2. They get oversubscribed heavily.

  3. The allotment of shares is in very small quantity.

Further, one should invest in an IPO of a company with good fundamentals with the aim of participating in the long term growth of the company rather than aiming to profit from short term market fluctuations.

I will invest regularly in a disciplined and systematic manner

It is now a well-known fact that the best way to create long term wealth with calculated risks is through systematic investment plans (SIPs) in equity mutual funds. Even for short-term goals or creating funds towards yearly payments (like annual insurance premium), you could do SIPs in debt/liquid funds or open recurring deposit account in a bank. The key here is discipline.

Take the case of Employee Provident Fund (EPF).The EPF gets adjusted automatically from your gross take home pay every month and you do not even perceive it as a deduction. A similar disciplined approach in equity mutual fund SIPs is likely to yield lucrative results. For this purpose, adopt the attitude of earn-invest-spend rather than earn-spend-invest. Maintaining an expense journal on a daily or weekly basis will help to plug the holes and cap unnecessary spending during these inflationary times. I have found that once an individual starts on this savings and investment program, he quickly gets habituated to it.

I will invest in shares and equity mutual funds with a long term investment horizon

Legendary stock investor Warren Buffet quoted ‘My favorite holding period is forever’. The most common query I get from investors is how long do I need to hold the investment? There is no right answer to that question because it would depend on a lot of things. But the generally accepted answer has been at least 5 years. Investment in equity/equity mutual funds for a long term horizon will help to iron out the short term volatility in the stock market.

There are mutual funds, which have been around since the 1990s and have weathered the ups and downs of the market over longer periods. For instance, Franklin India Bluechip Fund has yielded a 24 per cent compounded annual return since its launch in 1993.

The best way is to adopt a goal based investing approach. Knowing your target amount and also the time horizon will inculcate discipline. For instance, you require some amount of money for your daughter’s marriage after five years. Keeping that amount as your target, invest some amount regularly and during exceptional downturns. If your portfolio achieves the desired corpus for marriage funds, do not become greedy and wait for it to go up further. Book profits and invest that amount in fixed income instrument.

I will pay all my credit card dues on time and not avail of revolving credit facility

The trend amongst advisors nowadays is to recommend debit cards instead of credit cards so as to ensure you spend only what you have. A good idea no doubt, but to those of you who are disciplined enough not to overspend I would still recommend credit cards. Use credit card wisely to avail the benefit of free money until the due date and for travel, security, incentives and unforeseen situations like a medical emergency. The discipline should extend to paying the entire amount (not just the minimum amount) before due date as interest rates on credit cards range from an exorbitant 27 to 40 per cent per annum.

I will not mix insurance with investment

Think about why you require insurance. You want to protect your family goals like children’s education expenses or marriage expenses and providing for your spouse’s living expenses throughout his/her lifetime. Essentially it is a huge corpus. The corpus target will be difficult to achieve with expensive investment oriented policies. The cheapest form of insurance, which offers the best combination of coverage and cost is term insurance.

Insurance should thus not be mixed with investment. The main objective of investment is to build wealth through calculated risks while the sole aim of insurance is to cover for financial implications in the event of loss of human life.

I will buy adequate health insurance

You may not feel the need to buy health insurance in your 20s or 30s as you would be then in the pink of health or if you are covered for medical expenses by your employers.

However, not having your independent medical cover poses a few risks. Health insurance provided by the employer will cease to exist once you change your job or retire and it also does not offer flexibility in terms of coverage and other features. Secondly, you would essentially require a medical cover in your golden years and the probability is high that you would be denied one then. Given the exponential rise in healthcare costs, which is expected to continue, health problems are likely to drain your retirement funds in the absence of medical cover. So it is prudent to buy adequate health insurance for yourself and family right from the early working years.

I will not buy any financial product just to save tax

Each product in the market fulfills a particular need. Life insurance fulfills the need of financial security for the dependants in case of death of the income earner. Similarly, pension plan fulfills the need of a regular income after a person retires. Tax benefit is just an added perquisite on buying these products and should never be the sole aim.

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