Grow your Wealth:
Ten Tips to Grow your Wealth in a Systematic Manner Without Taking Unnecessary Risks
Various studies reveal that financial literacy levels are very low in India, especially among women and youngsters who lack even basic financial knowledge. In a small attempt to increase financial literacy levels, I have created this post to help people grow wealth in a systematic manner without taking unnecessary risks. Please share this post with your contacts to spread awareness about personal finance.
1) First Things First – Create an Emergency Corpus
Create an emergency corpus of 6-12 times your monthly expenses. -This money can be kept in places where you can access it easily and quickly in times of need like in saving bank accounts, sweep-in accounts (where excess funds are automatically transferred into a fixed deposit and earn higher returns), fixed deposits that can be broken online, liquid funds etc.
2) Health Insurance
Health insurance is a must for all. Else you might end up losing a large portion of your wealth in paying the hospital bills in case of a medical emergency in the family. If you are married, Instead of taking health insurance individually, take a family floater health insurance policy offering coverage to the entire family. Keeping medical costs in mind, take a family floater policy with a basic sum assured of Rs. 5 – 10 lakhs. You can also take a ‘super top up’ plan of 20-25 lakhs that covers the expenses incurred over and above the base health plan.
3) Life Insurance
i) Avoid using Insurance as an Investment
Avoid using Insurance as an Investment. Avoid Endowment Insurance Policies, money- back policies and ULIPs as they often have high expenses and cost that tend to reduce one’s returns. IRR (Internal rate of return) of most endowment insurance policies is between 4.5% – 6%
ii) Buy a Term Insurance Policy if you have Dependents
The only kind of life insurance one really needs is a term insurance policy. In a term insurance, money is paid to dependents only on death of policy holder. Buy a term insurance only if you have people who are financially dependent on you. Avoid going in for term insurance policies that offer return of premiums on survival. Avoid riders. Take the term insurance policy only till the age when you plan to retire. Instead of taking a term insurance policy of a random amount like 50 lakhs or 1 crore, use a term insurance calculator to calculate the amount of term insurance you need.
Retirement Planning: Use a retirement calculator to calculate how much money you will need for retirement. Save and invest a certain percentage (at least 10%) of your income every month for your retirement goal. Please see following article to learn how to build a simple retirement calculator in excel in 15 minutes.
Learn to Live Within your Means
i) Avoid Unnecessary Loans
Avoid taking unnecessary loans to buy consumer durables, automobiles or for going on costly vacations. Instead, save from your income regularly for these and buy them only when you can afford to pay the full amount.
ii) Don’t Spend more than 10% of your Income on Lifestyle Expenses
Limit spending on lifestyle expenses to a maximum of 10% of your income. This includes movies, eating out at restaurants, family vacations —basically, anything that doesn’t cover basic necessities. By sticking to the 10% rule, you can strike a good balance between saving for the future and enjoying life in the present.
iii) Go in for a Simple Marriage Ceremony Instead of Taking a Loan
Go in for a simple marriage ceremony instead of taking a personal loan to have a lavish wedding celebration. This is a very important point especially in the Indian context. I have come across young earners who had taken large personal loans to have a grand wedding. After paying their EMIs, they are left with insufficient money even to take care of their monthly household expenses post marriage. Please see following article on how delaying smartphone purchase can make you smarter
5) Track your Net Worth Regularly
Calculate your net worth every month. Net worth is the value of all your assets – all your liabilities (loans etc). Net worth is a true measure of your financial wealth and your goal should to be keep increasing your net worth. Remember that whatever we focus on tends to grow. If we focus on growing our net worth, we will tend to work on increasing our assets and not our liabilities.
6) Increase your Savings Proportionately on Increase in your Income
When you get a salary hike, increase the amount of savings accordingly, don’t just keep increasing your lifestyle expenses. Some have a goal of increasing savings by 10% every year – though this can be quite difficult to achieve, it can help one in achieving one’s financial goals faster.
7) Avoid Chasing Returns Blindly
Avoid investing in risky places like co-operative banks and co-operative credit societies for getting 1-2% extra returns. I have seen many people lose their money or lose access to their money due to closing down on co-operative banks and credit societies.
Remember the golden rule – the return of one’s investment is far more important than the returns on one’s investment. Instead of focusing on high-risk investments to get high returns, focus on increasing the amount of savings and the amount of time of investment (start saving early) to reach your target corpus for each of your financial goals.
8) Keep Learning and Increasing your Knowledge of Financial Products
Avoid buying any financial products – be it an endowment insurance policy, a money- back policy a ULIP, a company FD, a debt mutual fund or an equity mutual fund without first learning in depth about the various risks, expenses and returns (IRR – Internal Rate of Return) associated with them. Learn how to calculate IRR (Internal rate of Return) of insurance policies using XIRR formula in Excel – this is really a simple task.
-For long term goals, you can invest part of your money in tax free products from the Govt. like PPF (for any long term goal) and Sukanya Samriddhi Yojana (for daughter’s marriage and higher education expenses). Before you invest in these products, take out time to understand the withdrawal rules properly to ensure you have access to your money when you need it for your goal. Also understand that interest rates on these products get decided by the Govt. every quarter and may not remain constant.
9) Investing in Equity
i) Invest in Equity only for Long-term Goals
Although equity can be volatile, investing in equity is unavoidable as it is one of the only asset classes where one can expect post tax returns that beat inflation. Invest in equity only for long term goals beyond 10-15 years. Avoid investing in equity for short term goals that are 3, 5 or 7 years away.
ii) Be Aware of Expenses and Fees
The fees you pay your Asset Management Company (AMC), also called expense ratios, can eat into your returns. Even a fee as low as 1% can cost you a lot in the long run. Become aware of this.
iii) Manage Risk by Asset Allocation and Periodic Rebalancing
Before starting investing in equity via mutual funds, understand the risks involved and how one can manage them. Though a SIP is a convenient way to do systematic (regular) investment every month, it is not really a method to manage stock market risk. We need to remember that the amount we invest every month via a SIP remains invested in the stock market till the date of our goal and is subject to market volatility. One way to manage risk is by Asset Allocation and Periodic Rebalancing. To do this, set a target debt to equity ratio (how much you will invest in debt compared to how much you will invest in equity) for each of your long term goals like retirement, children’s higher education etc.
Take a look at your portfolio once a year to make sure that your debt to equity ratio still matches your target debt to equity ratio. For example let’s assume you want a 50:50 debt to equity ratio for your retirement goal and you had invested Rs. 50,000/- in debt and Rs. 50,000/- in equity at the start of the year. Let’s assume that due to a bull run in the stock market, the amount of money you had invested in equity has grown in a year by 20% to Rs. 60,000/- while the Rs. 50,000/- in debt has just grow by 7% to Rs. 53,500/-. To maintain your debt to equity ratio of 50:50, you would need to book profits of Rs. 3250/- from equity and invest this amount into debt. This periodic rebalancing can help in managing risk.
Follow these ten tips to grow your wealth in a systematic manner without taking unnecessary risks!