In this post we will discuss five key elements of personal finance. Before that, let’s have a look at the pie of salary above! For most of salaried folks, it looks somewhat similar to this, expenses and liabilities eating out the maximum! If you are one of them, you’re in trouble!
The allocation preference from your monthly salary should actually look something like below and take care of Five Elements of Personal Finance! If there is any mantra to personal finance management, this is it!
You just need to manage each step mentioned above in exact sequence. If you can do this, more than half battle is won!
Each step in itself is a topic and I’ll be writing detailed articles on each. For now I just want to give you a heads up on five elements of personal finance management –
You can’t avoid taxes, but you can manage them. In an ideal scenario, you must be making use of every possible tax exemption available within stipulated rules. In other words, you need to minimize tax outgo and maximize tax savings. Every year union budgets in India have some or other changes in applicable tax slabs and tax exemptions available on different instruments or investments. You should be aware of what is latest and applicable to you! Become an effective tax planner because only after paying taxes you’d be left with actual disposable salary, and you would surely like to be left with more.
Identify risks and get appropriate covers! Potential risks can eat up your savings very quickly, so keeping your risks sorted is a must. What are those potential risks? For starters, every salaried worker should have an adequate term life insurance plan and health insurance plan to cover life and health risks. Health insurance is a must for your old dependent parents.
Another risk can be a sudden loss of job or an unexpected requirement of money, in such scenarios you should have at least 3 to 6 months equivalent of your monthly salary parked as an emergency fund. This is important as otherwise you will have to liquidate your investments in such situations.
So, identify risks and start taking actions to mitigate them.
Once you have minimized your taxes and managed risks, comes the most interesting part of creating assets! Decide a monthly allocation from your salary towards investments and building assets.
An asset can be anything which earns passive income for you. For example, your investment in mutual funds or real estate. These assets will in turn earn for you and increase your wealth. You can decide which asset class to invest in based on your goals like buying a house or car, higher education or retirement. Out of everything, retirement planning is a goal that every salaried worker must have in their financial notebook! The earlier you start, the better. Remember, this step should always come before your expenses and liabilities. A penny saved, is a penny earned!
These are your regular expenses like house rent, travel expenses, monthly bills etc. Basically, these are your needs. You can only try to manage them and keep a track of these as you live off these expenses. I’m emphasizing on needs here since you are spending on something you need to. Any necessary and reasonable spends can be classified as your expenses.
This is what creates a hole in your pocket and makes way for money to go out! These are either the loans taken for some needs or money spent on wants. These are also things people buy thinking of them as assets, which actually turn out to be liabilities.
Lot of folks buy expensive cars thinking of it as a status symbol or asset, it’s not! For sake of an example, a car bought on loan will take out money from your pocket for interest paid on EMIs, yearly maintenance, insurance and fuel and will not give you any returns! Think about the alternates i.e. cab services or self-driven rented cars, can your travel needs be fulfilled by those? Why not only pay what you use? Even if you want to buy one, get it without a loan if you can afford it.
Any outstanding debt or anything that you don’t need but want is a liability to you. You should always try to move your allocation in liabilities column to assets column. Assets put money in your pocket while liabilities create a hole in it!
Now that you are aware of five elements of personal finance, take a break and analyze the state of your current allocations to each element. How many check-boxes you tick? Even if you don’t tick all the check-boxes, don’t worry. Stay tuned!
Your feedback, comments and questions are most welcome!