Where Do You Want to Reach?
In our article last week, we covered the topic of ‘Where Do You Stand Today?’.
We briefly went over the need and efficiency of having a financial plan, 3 simple financial thumb rules, and assessed whether we were living below or within our means i.e. are we spending or are we saving.
Moving forward we will see how to track our expenses and our savings with a simple and efficient budget.
The use of a personal budget is the simplest and quickest way of analyzing whether you are a spender, or a saver
And there are 4 Simple Steps to manage your money. .
Step 1: Know Your Income
Be aware of your Net Monthly Income (post tax).
This can be more than just your pay packet.
You can be receiving income from rent, from interest, from dividends and so on.
Make a mental list right now, and later on, write this all down.
Step 2: Know Your Expense
Make note of all your expenses. This will take a little time.
The main Expense items that show up in everybody’s budgets are:
- Grocery bill
- Spending on children’s school / college tuition fees
- Entertainment, including eating out, movies, shopping, gifts etc
- Electricity bill, gas bill, wifi for the home, any other utilities
- Travelling / fuel expense
- Telephone, internet, cell phone bills
- Medical expenses
- Miscellaneous and contingency expenses such as society charges if you own a home and others
Often, part of one’s cash outflow is for expenses and the other part is to fund existing liabilities.
So we come to Step 3.
Step 3: Know Your Liabilities
Keep track of your Liabilities. The main Liabilities that people can have are:
- Home Loan (the biggest and longest EMIs you will ever have to pay)
- Education Loan
- Car Loan
- Personal Loan
Cash outflows that go towards repayment of existing liabilities such as home and car loans, are funding the respective asset purchases. For example, EMI payments are regular, and significant, outflows from your monthly income. Be aware of the rate of interest on each of your liabilities, see whether you can avail a better rate elsewhere (refinance), and know the tenure of your loan.
Income minus all Expenses and Liability Payments will give you your Free Cash. It is this free cash that you will use to build your wealth and achieve your life goals.
Step 4: Build Your Wealth
Invest your Net Free Cash to build your wealth.
The free cash you have left after your expenses are taken care of is your net free cash. This is the money that will go towards building wealth for your financial goals and accumulating assets. And this is the most important part of your money life. It is these ‘leftover’ funds, also known as your investible surplus that will build your wealth.
So if you find yourself in a situation where your investible surplus is low, or close to nil, you need to very quickly rectify the situation.
The only way to do that is to cut back on unnecessary expenditures i.e. any expenditure that is not on a necessity.
Remember - it is better to first invest, and then spend out of what is left, rather than to first spend, and then invest out of what is left.
The beginning of all this is to start keeping track of your cash inflows and outflows.
Maintain your budget.
You can use PersonalFN’s free online tool - MyPlanner - to start maintaining your personal budget.
By the end of one month, you will have greater awareness on where your money is going and you will be able to streamline your expenses to increase your investments, ultimately building more wealth.
Now that you know where you stand financially today, you can put down on paper where you want to reach.
Once you have come this far - two things will be clear.
The first is that you need to set a target of where you want to reach in life - list out the things you want to achieve. You need to determine your financial goals.
The second should be that the more you are aware and knowledgeable of your finances, the better they will perform. Everybody would benefit from improving their financial literacy.
Let us address the first factor: Determining Your Financial Goals
We all live and strive for certain goals in life. Goals and objectives provide focus, purpose and vision to the financial planning process. By setting your financial goals you will be able to define your priorities, establish a direction and identify the results that you expect to achieve. When listing down your financial goals, take care to make your goals measurable, realistic and time bound.
STEP 1 Identifying Your Financial Goals
Common financial goals can include:
- Purchase of home
- Purchase of Car
- Child’s Education
- Supporting your parents
- Child’s Marriage
- Buying Holiday Home
- Wealth Accumulation
- Creating Trusts
- Charity / philanthropy
STEP 2 Classify financial goals based on their priority and proximity
- Short term (less than 3 years)
- Medium term (3 to 5 years)
- Long term (more than 5 years )
This will help you to know what goals are to be met first and therefore channelize your investments accordingly, based on the time to the goal and your risk profile. A simple table such as the one ahead will help you decide which goals are the most important (priority) and also see which ones are urgent (proximity).
Setting your Goals is typically not an ongoing process. You can set your goals and begin working towards them. Review of progress towards your goals can happen typically once a year.
The most important part of all this is just to get started. Once you do, you’ll find that you enjoy investing and building wealth because you know what this wealth is going to be used for - your family and yourself, in achieving your financial goals.