One Lesson – To Increase Your Personal Finance Awareness
What are the key components of Personal Finance?
Last week, I briefly described what is meant by personal finance. This week, I want to dive a bit deeper and understand the key components of personal finance. I will pick up each component and discuss them in detail in the following weeks.
a. Setting up an emergency fund – This should be the first item in your financial plan. This is a fund set up to help you in case of extreme emergencies. Like a loss of job or a big medical expense. One must always keep in mind that this fund is for emergencies only. And like Dave Ramsey said “Christmas is not an emergency”. It is recommended to have three to six months of expenses as an emergency fund. But I am a very conservative guy and I like to double up. My recommended emergency fund size is 12 months of expenses.
b. Adequate insurance coverage – Always consider insurance as a mandatory expenditure. Insurance largely covers term insurance and health insurance. Ofcourse there are other aspects of insurance like general insurance. But it falls later in the list of priority.
c. Debt management – This is a major component of personal finance. Debt could comprise of your home loan, car loan, personal loan, education loan or loan for entertainment and buying luxuries. If you do not have a home loan, I do not believe that one must have debt more than 10% of their net worth. Lower debt lets you sleep peacefully at night. I am open to a debate here.
d. Planning for Goals – We all have goals. We want to buy a house, a car, send our kids abroad for higher education or get them married. Out of all these, retirement planning is the most important.
Goals can be short term or long term in nature. Each individual has their own goals. One must spend some time to identify their goals and plan their finances accordingly.
e. Wealth creation – You can create wealth through proper financial planning too. I am not kidding. How much is relative to the income of each individual. We will definitely take a deep dive into this sometime soon.
f. Other key items – Other items include cash flow management, tax planning, and estate planning.
Please please let me know if I am missing out on anything.
One Idea – To Change the Way You Think About Money
Analyse where you are spending your money. Put your expenses in two buckets. Between “Things/Experiences I Love” and “Things/Experiences I Hate”. Keep in mind that you cannot love everything. You really need to be conscious in your selection and allocation. Now, cut your expenses mercilessly on things you don’t love. Once you do that, it will allow you to allocate more to your investments and also give you an opportunity to spend extravagantly on things you love. This will make you less guilty and let you enjoy more!
One Hack – To Add More Money To Your Bank Account
You are lucky if you are debt free. If you are not, i would want you to take a hard look at your existing borrowings and assess if someone is ready to refinance your existing obligation at a lower rate. There is always a lender who will be ready to do that. That ways, you save the differential interest payments which would add up to a significant number by the end of the loan tenure.
One Compounding Story – To Convince You About The Power of Compounding
Mr. Read, a longtime resident of Brattleboro, Vt., died in June at the age of 92. His friends were shocked when they learned his estate was valued at almost $8 million. Long widowed and with two stepchildren, he left most of his money to a local hospital and library.
He was a good stock picker, he displayed remarkable frugality and patience. This gave him many years of compounded growth.
He lived modestly, working as a maintenance worker and janitor at a J.C. Penney store after a long stint at a service station that was owned in part by his brother.When he died, Mr. Read left behind a five-inch-thick stack of stock certificates in a safe-deposit box. Mr. Read owned at least 95 stocks at the time of his death, many of which he had held for years, if not decades. Friends say Mr. Read typically bought shares of companies he was familiar with and those that paid out hefty dividends. When dividend checks came in the mail, he plowed the money back into more shares.
Key takeaways – frugality, consistently investing, being patient for decades.
My assessment – Practice frugality but by using the idea we discussed above. Key to creating wealth is investing consistently for long term. It’s difficult in this electronic age. One more hack I follow to avoid withdrawal of investments is investing in products with lock-ins. I even wrote a post on this topic here.
Like always, thanks for reading. I request your feedback. If you learnt anything, please forward it to your friends and ask them to subscribe.