An equation we all know: Income - Expenses = Savings and thus investments.
A less familiar equation: Multiple Income - Planned financial expenditure = Enduring Wealth.
Let's see how prudent spending can actually contribute towards wealth building. Expenses could be financial or non-financial in nature. Let us concentrate on financial expenditures and identify the same:
Insurance premiums, tax saving investments, debts (interest payments), service charges to banks and financial institutions, credit card companies, demat charges, non-life insurance premiums, professional fees of lawyers, accountants, wealth managers, financial planners etc are a few examples of financial expenses.
As we start using these or similar services, our obligation to these expenses becomes mandatory. Of course, we have exit routes but those can be costly as well.
Such expenses are necessary, but prudence can be used to identify the good among the bad and the bad among the ugly. Planning financial expenses is a healthy and rewarding practice, and does not mean compromising or cutting corners.
Understand the payback of each rupee spent. A rupee well spent translates into profits and thus wealth, and an ill-spent rupee becomes a wasteful cost, not to mention a loss of opportunity as well.
Let's get deeper into this.
Professional fees and charges
It's a good idea to spend on professional fees of lawyers, accountants, wealth managers and financial planners since this results in a tangible benefit to your net wealth.
Also, it frees you to do other things where you generate income.
Spending on service charges to banks and financial institutions, credit card companies, demat charges, non-life insurance, etc needs quite a bit of shopping these days.
You need to be aware of changes in charging policies, know who is charging what and take full advantage of schemes and offers. Be ready to switch if anything can have a negative impact on your cash flows. It is an effort, and is worth doing once in six months or so.
Bills and debts
Spending on debts, i.e. interest payments to lenders, can make your wealth bleed. If this is to a credit card company or payments to personal loan, your wealth is eroding and you are losing opportunity to invest that money and create more wealth.
If this is leveraged debt, i.e. planned debt for investments or collateral for business, purchase of assets like home / office, then this is fine and well worth the cost -- simply because it helps you to create more.
Investing
When choosing investments, you need to use your discretion to choose the product that is better in terms of certainty of returns, amount of returns, costs, taxation and related expenses. You have a limited amount of money and it must find its way into the best asset possible.
Insurance
Spending on life insurance needs maximum prudence as most people buy insurance out of emotion rather than financial sense. Buying a traditional children policy of the money-back variety is the worst thing to do. If you already have one, consider making an alteration to the contract.
If you are paying huge amounts as premium to traditional endowment type policies its time to restructure. Think about alteration, buy term assurance, as life insurance is essential and invest the rest into higher income and asset generating products.
Restructure policies or eliminate term assurance if you no more need insurance, i.e. if you have reached a level of adequate wealth or for people in the family who don't need insurance like housewives, etc.
Planning financial expenditure can play such a vital role in creating wealth that it is hard to imagine if you don't experience it yourself.
Kartik Jhaveri, an expert at Financial Planning, is a Certified Financial Planner and a Chartered Wealth Manager.
For more on financial planning, log on to click here.
More from rediff