A week ago, a friend called to wish me for the New Year.
After the usual exchange of pleasantries and enquiries about each other's families, the conversation settled on finance. Or, rather, the apparent lack of it.
My friend was worried about virtually everything under the sun -- whether he should invest in stocks or buy a home instead, whether he would have ample money for his retirement, and so on and so forth.
He asked me for suggestions but refused to disclose any financial details, be it his salary or the amount he has available for investing.
Which brings me the first rule of money management: Honesty works. Be honest with yourself and, if possible, with a financial planner or someone you trust.
Since he refused to part with any information, I ended the conversation with some general suggestions I hope will help him. You might find them useful too.
1. Get real
I, for one, would love to have Rs 1 crore (Rs 10 million) in my bank account by the time I turn 50. It's a great wish to cling to. But is it even vaguely realistic? Do I have any notion of how much I have to save to get that amount?
If I am 25 now and want Rs 1 crore when I turn 55, let's see how much I would have to save, starting now.
Inflation: Assumed at 7% per annum
Time period: 30 years
Current savings: Nil
To reach my target, I will have to save Rs 7,000 every month and it should earn a return of at least 8% per annum. This is not an impossible target, but it does not mean I will be rolling in luxury when I turn 55.
Let's say that my monthly expenses are Rs 15,000 a month. Going by the above example of inflation at 7% per annum, it will shoot up to Rs 1,14,184 in 30 years' time. These figures are not meant to elate or scare you; they are just to give you a reality check and a broad estimate.
You need to figure out what you are saving for, how much you need to save for it and how you are going to do it.
2. Get cracking
The key is to make your money work for you.
In the above example, we assumed a return of 8% per annum. Keeping your money in a savings bank account will not earn you that kind of interest. Despite occasional rises, interest rates in India are on a gradual decline.
So, let your money work for you. Amongst fixed return investments, the Public Provident Fund is a good option; it offers 8% per annum.
The younger you are, the more you should invest in stocks because time is on your side to ride the lows of the stock market. Over time, stocks give the highest return when compared to other forms of investment.
If you don't want to take the plunge into stocks, try diversified equity mutual funds. These are funds that invest in the stocks of various companies in various sectors. Else, try balanced funds. These are mutual funds that invest in both equity (shares) and debt (fixed return investments).
3. Learn to save
Investing smart is one thing. Spending wisely is another.
To get something, you have to sacrifice another. No one is asking you to live like a monk, but neither is it healthy to live like there is no tomorrow.
Take a good look at what is really eating away your income.
Is it the incessant partying and pubbing or shopping and eating out? Even if you cut your frivolous expenditure down by just Rs 1,000 a month, you have an extra Rs 12,000 at the end of the year.
My friend claimed that spending on cabs and auto rickshaws was chipping away at his bank account because he did not want to travel by trains or buses.
4. Are you honest?
You must be honest with yourself; with what you want and whether or not it is achievable. If not, see where you can compromise.
You may want to head to the West for a holiday, but can you really afford it? It may work out better for you to substitute it for a holiday in India. Or maybe an Asian destination.
You may want a three-bedroom apartment, but can you afford it? You may be able to if you settle for a city where real estate is not too expensive, or a home in the suburbs if you choose a metro.
Also, you may want to buy a home when you are 22 and have just landed your first job. It may, however, be wiser to wait for a few years till you have a higher salary and more savings to make a larger downpayment.
It's all right to dream. But don't let your dreams cloud reality. Once you get a grip on what you are saving for, you will be able to achieve it.