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January 18, 2000
The Importance of Planning
The Penguin Guide to Personal Finance
Money can't buy happiness. But the lack of it can buy a lot of misery. And let's face it. You are going to need it for the rest of your mortal life or until you die and maybe after that (for your children). And unless you start planning now, no matter what your age, chances are you will end up in a financial mess. Most of us will say, Me? In a financial mess? Never! Think again. Take a look at some of your requirements. Have you planned for the Rs 10-20 lakhs it will cost you to educate your child (and that's just for the bachelor's degree) in the next ten years? Or of how much you need in monthly income to retire comfortably without having to slog in your old age? Or, in the nearer future, of what would happen if you lost your job? It happens elsewhere in the world and it can happen here. And with no social security system worth its salt in India, I would certainly not wait for the government to bail me out. These are just a few examples of important financial milestones. There are many more that you will come across in this book and will have to plan for.
My parents did just fine without planning. What is so different now?
Our parents did not need to make as many decisions. The cost of living was low, insurance came from one or two companies, mutual funds guaranteed fixed dividends (it didn't matter that they ended up losing millions of rupees in the stock markets), college education cost less than the roasted peanuts we buy on the streets in winter. It was an investment Eldorado and even if you wanted to plan there was nothing to plan for. There was no choice. We wanted choice and we got it. But with choice, responsibility shifted from the government to us. Look at the spectrum of investment advertisements that appear. There is not only a choice of insurance policies but soon there will be a choice of insurance companies as well. Colleges will continue to reduce the subsidies on your child's education and you will have to foot the bill. And that house your parents built for a lakh and is now worth a few crores -- well you may never be able to keep the same standard of living unless you begin now.
There are a number of other things that are different now from what they were in our parents' time. Lifetime employment was a given and most children cared for their parents in their old age. That's not the case any more. Another key issue is that most of us seem to have more disposable income or wealth than our parents ever had. That may be a good thing, but it also entails that we know what to do with the money with us.
Where is the money to save and invest?
The fact is that most of us earn enough -- we all deserve more, but that's another story. Some of us even save enough. But investments -- that's for the aliens from Mars or my adviser or my friend or someone out there to think about. What do I have to do with it? One of the greatest paradoxes of life is that we work so hard to earn and save but think that it is beyond us to understand investments, let alone put our savings to earn the best returns.
One more feature about human nature, one peculiar to India specially, is that we tend to trust our advisers entirely to the extent that we refuse to even use our common sense. Most of us will go ahead and invest in a stock or a mutual fund just because our broker or our friend or our boss thought it was a good buy. And when our investments and our money go down the drain, we blame it on the government, the company, the system, India and whatever comes our way -- except, of course, ourselves.
We also have the tendency to feel secure about an investment if we see others going in for it, especially if they are our relatives, friends or peers. How many times have you invested in a company fixed deposit or a stock just because everyone you know is investing in it? If you are like most other people, I bet you that's exactly the way you invest. If you lose your money in such investments, it may comfort you psychologically that others you know lost money too, but it is not going to get back what you lost. But how many of us sit back and contemplate? Do we sit back and ask ourselves, Did I even spend an hour researching or asking independent sources about the stock I picked up? Without diligently following up on investment advice and putting our own minds to it, we should not blame the world for an investment disaster. Let's look at a classic example of how we risk our investments against our own good sense. A friend asks you to buy shares in a vegetable oil company. You don't really understand the stock market and in your experience, that oil brand is not selling well at your grocer or you heard that they sold adulterated oil on the news last night. You still pick up the stock. That's a classic case of going against common sense. A stock only reflects the actual performance of the company.
Let's look at a few facts. Did you know that your chances of earning a better return if you put in at least an hour a month to planning and tracking your investments were over 80 per cent better than leaving your money to find its own way and over 50 per cent better than letting the so-called professionals manage it. But then, does that really surprise you? Who would have more value for your money than you? As for the money managers, they charge fees to manage your money and of course have to maintain their five-star lifestyle and take their wives on expensive holidays. And who pays? No points for guessing that.
I am comfortable now and that's how it will remain
You have to change your assumptions. Managing your finances requires the discipline to deal with and change your financial habits. And good financial habits will put you in the driver's seat as far as your financial well-being is concerned.
Irrespective of the income strata you fall into, getting the basics of personal finance right is essential. I often hear, 'I don't have enough to meet my daily needs, let alone invest.' What is 'enough' is of course a relative term and if you give it a shot you will find ways of stacking up savings. And if things are so tight, you must find ways to save something. How are you going to manage if you lose your source of earnings, specially if these were just enough to make do?
COMMON FINANCIAL MISTAKES
Retirement is far away
Is it? My children will fend for me. Are you sure? Indian families are becoming more and more nuclear and children are so tangled with their own lives that this assumption is no longer a realistic one. Or we might think, my pension fund will be enough. The fact remains that most of us never plan to have enough retirement funds to maintain our existing lifestyles.
College education is cheap
Think again. Foreign colleges continue to reduce their aids and grants and in the next few years Indian colleges will stop serving free lunches, that is, they will charge what it costs them to educate your child. To educate a doctor it costs a college over Rs 15 lakhs and to educate an engineer, it costs over 12 lakhs at current prices. That shouldn't make you lose your sleep, but then it's time you got up half an hour earlier on Sundays and started planning your monetary needs in the coming years.
Losing your job
It happens to people I know, you think. But me, I am too smart to lose a job and my company loves me. Unfortunately, it's not always about you. It's about the company's own economics. Tough times require tough measures and companies cut employees across the board when the going gets tough. Indian companies (and even the government) are shaping up and reducing their workforce. Don't take a lifetime employment (something our parents took for granted) as a given.
No one expects to develop a serious illness. But if you do, do you have the medical insurance to cover it (check your insurance policy again). Or do you have three to six months' worth of monthly expenses in cash to cover an emergency?
Dealing with money without a plan
Many of us leave money in investments for years (and can't even find the documents), many of which may have gone belly up. Or pay higher taxes because we scramble to pay up on the tax deadline. Or have not thought if we have enough funds to retire comfortably. Or if we have enough insurance coverage, besides other requirements.
Buying consumer goods and non-productive assets on credit
It's a double whammy. If we are using credit cards for anything other than convenience (of not having to carry a wad of notes), we are simply mortgaging our future earnings to paying off debt. Additionally, if we don't pay the entire balance on our credit card by the due date, we get charged interest from the date of purchase for all future purchases. And you get no tax deduction on the interest you pay for car or credit card interest payments. Given the interest rates you get charged on credit card and car loans, you will have to find an investment that produces over 20-24 per cent interest to match up the interest charges on these loans. Isn't it simpler just to live within your means?
Falling for high interest rates and upfront commissions
Talk about losing your shirt for a free button. India is littered with investors who have lost their entire life's savings in plantation companies, company fixed deposits, nidhis and child funds and just about every investment you can think about because greed took over their common sense. The lure of a 1-2 per cent upfront commission or a gift and a dubious promise of gravity-defying interest rates sent investors raiding their bank deposits to put money in schemes that ended up gobbling up even their original investment.
Letting feelings overrule financial logic
Many investors I know who have lost money in stocks try to double their investments in these so that they can recover what they have lost with little regard to the fact that they could lose even this. Or for that matter, buying a son or daughter a car, or a diamond necklace for your wife that you cannot afford just because you don't want to annoy them. Spending what you cannot afford is like the high a drug addict gets when he takes drugs or an alcoholic feels when he drinks. The hangover is worse.
Leaving yourself financially exposed
Certain events, such as a fire, could destroy us financially or at least put an unbearable load on our finances. Is your house and its belongings insured for fire, theft, earthquake, etc.? Do you have medical insurance to cover any major illness? Is your small business covered for thefts by employees? These are just some examples. Most of us have rarely sat down and analysed events that could destroy us financially and considered insurance to cover or minimize these risks.
Not taking responsibility for your investments
Most people invest haphazardly on advice from trusted friends, relatives and others. People rush into an investment because 'it's a one-time deal'. How many times have you heard, 'Get in now or you will not be able to buy it,' 'There at least a 100 people waiting to buy,' 'This is the last plot.' It's your money and trust me, it feels a lot better to have it than to lose it. Don't jump into making investments even if you 'lose a deal'. It's not the end of the world. And chances are that if you rush into an offer you will lose money rather than make it.
Not having a will
The only thing that is certain is death. The uncertain part is that you don't know when it will come. Passing away without a will could leave our loved ones in a financial soup.
Failing to save for retirement
For the greater part of our lives, we look at the retirement years as someone else's life. Why is it that just because your employer thinks that you have reached the end of your productive life, you don't need to have a living standard similar to the one you had before retirement?
You don't learn about managing your money through the educational system and even if you picked up your parents' good financial habits, they may not fit in your scenario. Our fathers love the good old bank deposit and would not put their money anywhere else. They grew up without a host of other exotic investment products like mutual funds and bonds of various types. That requires you educate yourself and read up regularly on the financial choices available to you.
Financial illiteracy passes on for generations
For some strange reason, discussions of money within the family are frowned upon. Financial ignorance passes on from generation to generation. Most families discuss money only when there are disagreements or disputes on who gets what, a death that leaves siblings fighting for their share or a financial crisis. But all you are doing is pushing things under the rug and at least in my experience it all ends up in squabbles and fights on who owns what. The world is getting very competitive and your kids need to be educated about personal finance. You will be passing on to your children tools they will be able to use to build a long-term financial base. The question is, when and what do you tell your children about money? When they are around fourteen or so, take them to a bank and let them open an account. And then whenever you give them their pocket money, deposit it in their bank account. That way, they get to track what they have.
Believing everything we read
At the end of the day, most publications rely on advertising revenues and some of their advice on financial products could be biased. I am not saying that you should not believe what you read, but take it with a pinch of salt. Don't rush to buy a share just because a financial daily recommended it. If you need proof of what I am saying, just go back and see what the financial press was recommending and what has happened to those 'best buys'.
Another note of caution. A market expert who appears to be dishing out his recommendations on every TV channel and newspaper is not necessarily the best source of information. The expert may just have the best public relations team which manages to get him on every media source.
For those of you who read or watch financial news, numerous pieces of investment advice, often conflicting, pass by your eyes. Many tell you about how the stock market or the real estate market is bottoming out and how it is the best time to buy. But wait a minute -- they don't tell you if it's the best thing for you to do since they don't know your personal situation. If you look hard enough, the best and safest investments are usually bought after careful research and perform well when you hold them for long periods of time.
(Excerpted with permission from The Penguin Guide to Personal Finance by Ashu Dutt, Rs 250, Penguin)
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