Planning of finances is essential for each and every one, be it a school-going kid
or a retired citizen. The more early you begin to manage your money the better it
is. Let’s suppose you choose not to plan and keep spending as and when you like
and one day you wish to purchase a house but then you cannot as you hardly have
any savings left. This is what happens when you don’t plan and end up overspending.
We tend to overspend when we do not understand what we really need. We keep on spending
to fulfill all our requirements and we lose count of how much we spent. One should
understand the difference between your needs and wants. Things like daily lunch,
dinner and house rent payments are our needs which we will have to incur. But things
like play stations, videogames and movies are always an option and can be done without.
If even we do want to splurge on our wants we can set aside some of our savings
over a time period and can buy important needs like vehicles, house, higher education
etc when we have accumulated savings. This is what planning is all about, to plan,
save and help us achieve our financial goals. When you start early you can always
plan for your future financial goals and have the benefit of meeting them when you
want to. This is because you have a longer time horizon to spread out your investments
and manage your portfolio across time. Every school-going kid is taught from his
childhood to count and save money for his future so that he can use them appropriately
to finance his financial goals.
This tutorial on financial planning presents various aspects of financial planning
for college students. Financial planning is very important for every individual.
If people understand its significance at a younger age, achieving your future financial
goals becomes more convenient
Setting Your Goals
When you set goals, you're defining your dreams for the future. Some of your goals
maybe things that you want soon, like paying off your credit card debt or buying
a new car. Other goals may be more distant. Do you want to buy or build a new home?
Start your own business? Pay for college for your child or grandchild? Retire early?
Your goals are the foundation of your financial plan because you need to know what
you want to accomplish before you can begin Saving or investing. Once you’ve identified
and prioritized your financial goals, you can develop a clear-cut savings or investment
strategy that can help turn your dreams into reality.
A critical first step in managing your finances is to be able to setup SMART financial
objectives. Your goals have to be S (specific), M (measurable, motivated), R (realistic,
resource-based), and T (time-bound, can be monitored). Many people make the mistake
of setting general goals which, more often than not, will not materialize.
How To Achieve your Goals?
The following excerpt is a conversation between a college student, Shantanu (17),
who is pursuing his graduation in Finance, and his elder brother, Nikhil (35), who
is working as a financial planner. The conversation gives an insight into planning
and introduces the concept of financial planning.
Table 1: Goals for Mr. Shantanu Age 21
Risk V/S Returns
Every individual has their own risk taking capacity. Your risk-return profile is
your level of risk tolerance. If you invest in a high risk business like a start
up firm your risk would be high. There are three types of risk return profiles which
you can fall under depending upon your source of funds and the investments you choose
to make. They are:
- Conservative i.e. you take minimal risks ensuring your funds are secure. You prefer
investing in post office deposit schemes, bank fixed deposits, government bonds
- Moderate i.e. you are willing to take some risks and prefer investing in mutual
- Aggressive i.e. you are willing to take high risks and prefer investing in equity,
commodities markets and you may even be speculating for returns.
There is an important investment principle which says the level of your returns
depends on the level of risk you take. While you stay invested it is crucial you
take necessary measures to manage your risk. Once you invest in any asset class
you should monitor your investments and keep yourself updated about various market
happenings to avoid any pitfalls. Always check the potential risks when quoted returns
are unusually high.
The Power of Compounding
Time is an influential factor when it comes to investments. Your returns depend
upon the time you enter and exit. Compounding is a concept which when followed with
dedication gives great rewards. However, it rewards better when savings are compounded
over longer horizons. Compounding, in short, basically means earning interest on
previously earned interest. Let us look at an example:
If you set aside a sum of say Rs 5,000 every month from the age of 25, at a return
interest rate of 10%, in 60 years you will have with you funds worth about Rs 1
crore (Rs 10 million) and more. However, if you start at 40 with the same amount
and return rate of interest, the retirement fund will amount to only around Rs 33
lakh (Rs 3.3 million). Consider you invest Rs 100 for a period of 5 years.
Notice here that the Rs 100 that you had invested will fetch you Rs 161.05 in 5
years in terms of fixed interest rate and similar results in terms of floating rate
as well. Thus in 5 years you stand a chance of making around 60% return!!!
Thus compounding is a tool that helps you make phenomenal growth in your investments
over a period of time. Thus the more time you have, the more money you are capable
of making and this is exactly why financial planning is so very important.
Recurring deposits and SIPs can help you on this front, ease in payment of this
regular investment amount through a direct debit facility or post-dated cheque can
help you execute your compounding strategy.
Inflation Effects on Investment
Inflation is rise in prices for goods and services. As the prices rise, lesser number
of people can buy them. Let’s say the rate of petrol changes from Rs 40 to Rs 45,
with no change in quality. Then the price difference indicates inflation.
If you are earning returns of 10% over your investment of Rs 5000 which is Rs. 500
after a year and the inflation rate is 11% then you will end up giving your returns
due to high inflation rates. Hence always ensure your returns are above the inflation
rates. You should also understand the time value of money.
Inflation Effects on Investment
What are the measures I can take to minimize my risk?
SHANTANU: Why do I need to invest in various asset vclasses? Rather
if I invest in just one I don’t have to maintain a huge Portfolio. Also, managing
just one asset class sounds a lot easier. I can also save on the portfolio manager’s
NIKHIL: Well when it comes to investment one should remember That
investing in various asset classes has its own advantage. When You distribute your
investment across various asset classes, your risk Is balanced out across the portfolio.
Let me give an example (Look at how Nikhil explains diversification in the following
NIKHIL: Suppose the amount available with you for investing is
Rs 10, 000. You make investments in various assets. You invest Rs 3500 each in equity
(which are shares or stock of a company) and bonds which may be government securities
or corporate bonds. The rest of the funds are allocated to commodities, let’s say
gold or silver, which is termed as bullion in commodity markets. Now, say the company’s
shares in which you have invested have not performed well then there is a possibility
that you may lose money on the capital invested in these shares. However, since
you have invested in other asset classes the decrease in value of any one asset
will be balanced by the gain in other asset classes. This is the benefit of diversification.
Diversification thus reduces the risk of the portfolio. If two asset classes are
correlated, it implies that when one asset class does not perform well the other
asset also loses value depending upon the extent to which they are correlated. If
they are positively correlated the direction of movement would be the same but if
they are negatively correlated they would move in opposite directions. Investors
park their funds in different asset classes with a motive to even out the losses
in one asset with the gains in other asset classes. One should always analyze the
fundamentals of the company before investing in its products. If one wishes to invest
in equity markets, he or she may choose to do so by investing in blue chip companies
which have good fundamentals rather than investing in companies whose business you
do not understand.
Every asset class has its own risks and returns. Equity investments are considered
to be risky investments as they might lead to erosion of entire capital invested,
whereas government bonds are considered to be risk free as you are confident that
the government will not default on its interest payments. When it comes to choosing
what investments would suit you, a financial planner will tell you about various
asset classes and will help you allocate your funds appropriately. This is termed
as asset allocation. In other words, now you would begin implementing your financial
plan. Asset allocation is a technique for investing your money into various asset
classes. Your planning consultant will suggest assets that would suit you according
to your income and risk appetite. If your risk appetite is high, he would suggest
risky assets, but if your risk appetite is low, then he would suggest less risky
assets. While allocating your funds to various assets, it is important to see that
you distribute your funds across various assets to benefit from diversification.
Savings V/S Investments
Savings mean the funds you keep aside in safe custody like bank saving accounts.
While investing on the other hand means to purchase various financial instruments
which will pay you a return on some future date. The difference between savings
and investment is that savings is simply idle cash while investments help your funds
to grow over a period of time. We can meet our short term needs with our savings
but to meet our long term goals we need to make investments. Savings help to protect
our principal while investments help us earn returns over our investments
Loans V/S Investments
People always are confused whether they should avail a loan or build investments
to achieve their financial goal. Both of the options are different and should be
availed appropriately. The following points are worth remembering:
- It purely depends on your financial strength and other factors.
- Credit card debts and personal loans are very costly
- If you have a loan with a low interest rate and tax benefits as in the case of home
loans, it is advantageous to go for a loan. If you have an investment plan where
you can make good return, and then you may opt for investment.
- You have to be sure that the investment is not risky and will not affect your family
if you lose the money. For example, you are investing huge sums in share market,
instead of closing the existing debts, that is too much risk.
Basics & Dangers of Credit Cards
SHANTANU: I was thinking of getting a credit card? Should I?
NIKHIL: People of your age fancy credit cards, they feel that having
a credit card is like a status symbol because it gives them the ease of payment
at any time but what they forget is the bill they need to pay later.
- Credit cards come with a lot of additional charges like interest rates, service
charges etc. in exchange for the credit offered by them. People forget to read these
terms before purchasing a credit card.
- Credit cards often tempt people to spend more even if they do not have money today
as they have the comfort of paying back later.
- People tend to purchase more credit cards so as to extend their income and later
end up piling huge sums of debt
- Credit cards offer a number of gifts like cash back, holiday vouchers and other
coupons on making purchases through using credit cards.
- Credit cards offer the benefit of traveling without cash.
- Credit cards offer cash in advance and hence are easier to use.
It is advised that one should learn to save and manage their funds wisely. Always
try to cut back on your spending and rethink before you buy any items other than
your basic needs. People at your age are very keen on electronic gadgets and wish
to spend on the latest in town. But what you do not realize is these gadgets cost
quite a lot on your pockets, squeezing your bank
I remember even I need to pay back my educational loan
after I complete my graduation. I had completely forgotten about this.
I am glad you told me about your loan before you registered
for a credit card. If you already have debt to repay why should you go for more
debt? It will not help your financial position. You should instead make investments
that will help you repay the loan and also support your needs for the future.
Indian markets offer a number of financial instruments like equities, debt, mutual
funds, currencies and commodities in addition to other structured products. However
their choice should be appropriate for the investor depending upon his or her risk
profile and other investment horizon.
For younger age group individuals since the investment horizon is long one can invest
in products which offer capital appreciation or growth on investments. One should
always check that he or she has allocated funds to spend on his or her immediate
needs before investing.
These are company sponsored instruments like shares or stocks of the company’s capital.
These instruments offer the investor with shareholder rights where in investors
can participate in the annual general meeting and have the right to vote. These
products earn returns depending upon the profits made by the company from its operations.
The returns may thus fluctuate depending upon the profitability of the company business.
These products offer a number of benefits like Investors should understand the company
business very well before investing. One can choose to invest in these instruments
when they have a longer investment horizon.
A mutual fund is generally a professionally managed pool of money from a group of
Investors. These products may range from asset class specific portfolio or a mixed
group of asset classes. But the choice of scheme or plan should depend upon your
investment objective. Investing in mutual funds helps in diversifying your portfolio
and thus reduces the risk in your portfolio. These products are considered to be
ideal for beginners who lack the necessary expertise to manage their funds.
Structure wise there are two types of mutual funds – Open ended and closed ended.
OPEN ENDED SCHEME sells and repurchases units at all times. When
fund sells, investor buys and when the investor redeems, the fund repurchases the
units. Buying or redeeming is at a price based on the NAV (Net Asset Value).
CLOSED ENDED SCHEME, after the offer closes, investors are not
allowed to buy or redeem units from the fund. Closed end funds are listed on stock
exchanges to enable investors to buy or sell units.
Insurance is more a safety option than an option to invest. We buy insurance to
ourselves from unforeseen events like death, accidents, theft of valuables etc.
Some of the
common insurance plans are:
- Unit Linked Insurance Plans
- Term / Term with Return of Premium Plans
- Health Insurance
- Personal Accident Insurance
- Insurance cover for your Home / Car
- Insurance cover to protect your family from liabilities
- Travel insurance
The value of the cover that you opt for should depend on your need for protection.
Life insurance helps your dependent family members to cover daily expenditure in
case of any sad demise. Medical insurance covers your hospitalization expenses in
case of any critical illnesses. Within this category, products may have different
payout structures and limits for various heads of expenditure. The hospitalization
coverage may be reimbursement based plans or fixed benefit plans. These plans aim
to cover the more frequent medical expenses.
Systematic Investment Plans:
Starting early is the key to financial planning; today you don’t necessarily need
to inherit wealth from family to get wealthy. SIP or systematic investment plans
are an excellent means by which you can start investing small, fixed sums of money
at regular intervals, (commonly 1 month) most
The Concept of Rupee Cost Averaging
SIP uses the concept of rupee cost averaging. Let me illustrate this with the help
of an example:
Rs 500 invested in January would fetch you 100 units compared to just 41 units in
the month of April. Thus by investing the same amount of Rs 500 every month, you
buy more units when the market is down and buy fewer units when the market is up.
Thus lowering your average cost per unit. SIP acts as an excellent means by which
you can save time and efforts in tracking the stock market movements.
How Not to Lose Money?
Updating oneself with the current happenings is a must for every investor as he
will then be aware of various events in the financial markets. In addition to this,
there are various matters that need to be looked into to keep a check on your portfolio.
If you do not then you will end up losing all your returns
You should make a habit of analyzing your investments, valuing your investments
and rebalancing your portfolio.
If you are investing in mutual funds, you can keep a watch on the daily NAV (Net
asset value) of the particular fund just like you watch the daily stock prices.
You should also be aware of various financial ratios like profit margins, solvency
ratios and liquidity ratios, which give you an idea of how the said company is in
terms of profitability of its projects, share value and other factors. If you are
investing in bonds you should be aware of the bond’s maturity, the rate of interest
and other elements of the bond. If you are aware that the company has earlier defaulted
on its interest payments on its borrowings, then it is better not to invest in securities
of that firm. It is always safer to have a good know-how on valuation techniques
like ratio analysis and investment pay-off.
You should keep an eye on how the value of your investments changes depending upon
fluctuations in the markets, economic issues and other factors.
You can analyze your investments by looking at financial statements of the companies,
see how they have performed in the past and if you expect that the company will
perform well in future, then you can think of investing in that company. You should
try to familiarize yourself with the financial statements of the company to understand
how the company utilizes its finances. You should be wary of the publicity gimmicks
that a company would put up to impress the masses. You should develop a knack to
read through what the company writes up on its performance as a part of the results
declared. Every investment you make is crucial hence you should monitor it from
the time you invest into the investment product till the time you receive your proceeds
from the investment. The time period from the beginning of the investment, that
is when you pay out from your funds to buy an asset, till the time you receive your
proceeds from the sale of the asset is termed as the Investment Life Cycle. Every
investor should monitor his investments from the time of entry till the time of
exit. Throughout the time horizon you stay invested you should maintain a check
on your investments. The time horizon varies across investors. Some may enter and
exit trades within few minutes, hours or within a day while some stay invested for
years. But it is always advised that investors should remain invested for a longer
time horizon to benefit from an investment. The longer you stay invested you attract
less taxes also. But many do not do that in the hope of making quick profits.
Every individual should know about the tax implications on his or her investments.
individual is charged income tax but the charges vary depending upon under which
bracket he falls.
However when it comes to investments you can get a tax rebate.
Section 80C of the Income Tax Act allows you to get a rebate up to a limit of Rs.
1, 00, 000 which is irrespective of under which tax bracket you are. This covers
- Provident Fund
- Public Provident Fund
- Life insurance premium
- Pension plans
- Equity Linked Saving Schemes of mutual funds
- Infrastructure bonds
- National Savings Certificate
Section 80D of the Income Tax Act also allows you to get a rebate over premium payments
of medical insurance plans. This is over and out of the Rs 1 lakh limit offered
by Section 80C. 80D provides a deduction up to Rs 30,000. For senior citizens, the
deduction up to Rs. 20,000 is allowable. This deduction is available for premium
paid on medical insurance for oneself, spouse, parents and children. It is also
applicable to the cheques paid by proprietor firms.
This act also exempts home loan payments. For self occupied properties, interest
paid on a housing loan up to Rs 150,000 per year is exempt from tax. However, this
is only applicable for a residence constructed within three financial years after
the loan is taken and also the loan if taken after April 1, 1999.
How to Begin Investing?
One can begin investing by fulfilling the following steps:-
1. Investor must have the following documents
- Personal Identification Proof – PAN Card, Passport Copy, Driving License copy
- Address proof – Utility bills – Telephone bills, Electricity bills
2. Investor should approach an intermediary which may be a broker, relationship
3. Investor is then required to fill up the KYC (Know your client) form and should
furnish the necessary details. In addition, he would have to fill the broker-client
4. Investors then need to open a demat account and a clearing bank account. For
this, he or she would have to furnish his or her bank account details.
Once these steps are completed an investor can begin trading in financial markets.
In case of any disputes, investors can approach the following authorities –
SEBI - Securities & Exchange Board of India
MCA - Ministry of Corporate Affairs
RBI - Reserve Bank of India
MOF - Ministry of Finance
FMC - Forward Market Commission
IRDA - Insurance Regulatory and Development Authority