Wednesday, 13 August, 2014

Being Disciplined

Being Disciplined

When it comes to personal finance, people tend to assume that they need to do a whole host of things and consult a zillion “experts” before they can get on to their “Path to phenomenal wealth”. They are completely off the mark and totally wrong.
While things are not altogether simple and absolutely easy so as to be trivialized, they are very much within the realm of possibility and can be accomplished by virtually each of you.
The trick is to
  1. Start early
  2. Be disciplined and
  3. Stay put
Of the above three steps, I would personally regard the second one to be the most critical: Be Disciplined!
Here are some easy-to-execute tips for being disciplined on the financial front:
  • Today, identify a time-slot when you will actually sit and start your basic planning process.
  • At the outset, jot down ALL your sources of regular income
  • Similarly, identify ALL your regular expenses that are completely unavoidable (Like Rent, Taxes, Electricity bills, Monthly groceries, etc.)
  • Identify a percentage of your regular income which SHALL be saved each month. In the initial years of your career, when financial commitments are typically lower, the percentage can be much higher than, say, when you’re married, have a couple of kids and a couple of loans.
  • Convert this percentage into a nice, round figure, say, to the nearest thousand or nearest hundred.
  • Each month, shift this amount AUTOMATICALLY to a separate bank account which will be a “One-way bank account” – This bank account will NEVER be used for routine withdrawals for regular expenses 
What you should do with this “One-way bank account” is the subject matter of a separate blog post, and will be dealt with in the days and weeks ahead.
For the moment, start off with the aforementioned “baby steps” to become financially disciplined. Those of you who are familiar with the Power of Compounding would know the likely positive impact due to these “baby steps”. The rest of you may wish to do a Google search to find out about what Einstein famously referred to as the “Eighth wonder of the world”. Or, if you so desire, refer to my own blog post on the Power of Compounding a few years back (Using the Power of Compounding).


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Monday, 11 August, 2014

Maximizing Employee's Contribution to PF - To do or Not to do?

Maximizing Employee's Contribution to PF

To do or Not to do?

A couple of days back, a friend told me about his young IITian son’s first job. In the course of his conversation, he mentioned that he had advised his son to go in for “maximizing” the “Employee’s contribution to Provident Fund” so as to build an “automatic savings corpus” right away.
I did proffer my opinion about the same in brief – that it may not necessarily be a great idea if the individual concerned happens to be a thrifty individual and has adequate self-discipline, especially in matters pertaining to personal finances. During the course of the weekend that followed, I thought further about it. And here are a few of my thoughts: 
Considering the temptation to blow up one’s “newly acquired monthly inflows”, it is indeed a good idea to send away a part of the money “automatically” into the savings pool before it reaches one’s hand. This is certainly true for the vast majority of youth today. Even more so if the young kid satisfies one (or both) of the following two conditions:
  • The monthly income is just about sufficient for maintaining the chosen life-style of the concerned individual and / or,
  • The individual concerned is likely to yield to the temptation of blowing up all his/her money as soon as it lands up in the bank!
From anecdotal evidence, I would guess that at least one of the above two conditions will apply to well over 95% of people entering the corporate world today. My mom (and people of her generation) would be tempted to say that the figure ought to be 99.99% J!
What about the folks who don’t satisfy even one of the above two conditions? They will be under immense pressure from their parents, friends, colleagues and perhaps even some so-called financial experts to maximize the “Employee’s contribution to PF”. The logic would broadly be as follows:
  • “You’re earning quite a bit considering your life-style – Obviously you will be able to save this sum without even noticing it”
  • “The power of compounding works like magic – Before you realize, this contribution would have grown immensely”
  • “If you don’t save this money, you will spend it or lend it or give it or otherwise fritter it away”
At a superficial level, the logic is quite appealing. But I’m not convinced. In fact, I would strongly urge such an individual to ignore the logic and contribute the MINIMUM possible amount to the “Employee’s quota” of PF Contributions.
Here are a few reasons:
  • Being self-disciplined and financially thrifty, he will in any case save enough of his money on his own – He doesn’t HAVE TO maximize his contribution to PF.
  • In any case, the Provident Fund fetches a ridiculous sub-10% returns on the savings. This doesn’t in any way cover the real inflation rate that will be applicable to an upper middle class individual.
  • More importantly, considering the long-term horizon for this individual’s savings, he ought to look at maximizing returns, rather than safety. In fact, the past track record of the past 10, 20, 30, 40 and 50 years would confirm that returns of systematic monthly recurring investments equity shares / equity mutual funds have consistently and significantly outperformed any fixed income products like Bank deposits, Provident fund, NSC, etc. Hence, risk becomes almost a non-issue.
  • The same logic would perhaps hold true for investments in real estate as well.
Hence, I re-emphasize my initial point:
  • “If you’re a disciplined individual, thrifty by nature, you must MINIMISE your contribution to the Provident Fund”.
Instead, you MUST do the following:
  1. Shift any surplus funds over and above your typical monthly expenditure into a highly rated liquid mutual fund.
  2. From the balance in this liquid fund, build a corpus of perhaps 3-6 months of monthly expenses (not monthly income) and park it in a carefully chosen short term debt fund.
  3. Identify your real insurance requirements (Typically you will require a Term Insurance Plan to cover your life, a health insurance plan and perhaps an Accident Insurance plan) – Explore the possibility of taking adequate insurance cover for all these requirements.
  4. Once this “Emergency Fund” corpus as well as your Insurance needs are both “ready and done”, identify 3-5 high quality equity oriented mutual funds and start a Systematic Investment Plan to invest your routine monthly surplus to these equity oriented mutual funds.
  5. Stay on the look out to buy your own home For Living – As and when you identify a suitable property, you may wish to consider taking a suitable housing loan and buying that property.
  6. Watch out for the launch of high quality Real Estate Investment Trust products (REITS). SEBI and the FM have just approved the concept. I’m sure that reliable and trustworthy players like HDFC, Tatas, Birlas, TVS Group, SBI, L & T, etc. will very soon come up with their own REITS. Considering the fact that under the proposal, long term capital gains from REITs (units which are held for over 12 months) are likely to be completely exempt from Income Tax, REITs are bound to be hugely popular investment avenues for those who wish to park their funds in Real Estate for investment purposes. (To put things in perspective, if you sell a house that you have been living in for the past few years, your capital gains will be completely taxable, whereas, a corresponding investment in REITs would be tax-free).  
In a nutshell, remember that unlike your spendthrift friends who blow up their money, you are disciplined and thrifty. Hence, make the most of it and kill the monster of inflation with your hard-earned savings. Saving money is just the first step. The next key step is to convert your savings into investments.

This, I’m sure, will not only make you immensely wealthy over the next couple of decades, but will also ensure that you will be able to become financially free by the time you hit 40.
Don’t waste your money by maximizing your contribution to PF!
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