June 22, 2017

In all my financial interactions be it planning for clients, training, teaching or writing, people have come to me with some problem which they think is unique. In all the financial problems, I am able to find a pattern. Believe it or nor, people more often than not choose the problem by their behavior. It is easy for me to find a pattern and say, “Well you chose your problem, did you not?”

Your financial problems would have been caused by some (or all) the following financial behavior:

 ➡ Not planning:

The single biggest problem for most people is that they just do not plan their finances. Even if they are not happy about the results of what they have done so far, they do not change the way things are done.

➡ Overspending:

Many people with not very high incomes have very high ambitions. Most of this problem is because the salesmen in most shops do not tell you the price of a product, they only tell you the EMI — so anything from a plasma TV to a luxury home on the outskirts of the city are made to look cheap! After all at Rs 2,899 a month does a plasma TV not look cheap?

➡ Not talking finance at home:

Children are kept away from the finance topics at the dining table. Finance is perhaps the second most taboo topic at home! So many children grow up without knowing how much of sacrifice their parents have gone through to educate them.

➡ Parents spending on education and marriage:

There are just too many kids out there who believe that they need to worry about savings, investment and life insurance only at the age of 32 plus. This means your father, father-in-law or a bank loan has funded your education and marriage. Kids should take on financial responsibility at a much younger age than what is happening currently.

➡ Marriage between financially incompatible people:

Most marriages under stress are actually under financial stress. Either the husband or the wife is from a rich background and the other partner cannot understand or cope with the spending pattern. It is necessary to match people financially before marriage.

➡ Not prepared for medical emergencies:

Normally big emergencies — financially speaking — are medical emergencies. Being unprepared for them — by not having an emergency fund is quite common.

➡ Lack of asset allocation:

Risk is not a new concept. However, it is a difficult concept to understand. At 3k index people were afraid of the market. Now everybody and his aunt wants to be in the equity market — and there are enough advisors who keep saying, “Equity returns are superior to debt returns.” This is true with a rider — in the long run. So there could be a much larger allocation to equity at higher prices — to make for the time missed out earlier.?

➡ Falling prey to financial pitches:

The quality of pitches has improved! Aggressive young kids are recruited by brokerage houses, banks, mutual funds, life insurance companies, etc. and all these kids are selling mutual funds, life insurance, portfolio management schemes, structured products, et al.

➡ Buying financial products from ‘obligated persons’:

This is perhaps one of the worst things you can do in your financial life. A friend, relative, neighbor, colleague who has been doing something else suddenly becomes a financial guru because they have become an agent! You are saddled with a dud product for life!

➡ Financial illiteracy:

Most people do not wish to know or learn about financial products. They simply ask, “Where do I have to sign” — so buying a mutual fund is easier than buying life insurance!

➡ Ignoring small numbers for too long:

What difference will it make if I save Rs 1,000 a month? Well over a long period it could make you a millionaire! So start early and invest wisely. It will make you rich. That is the power of compounding.

➡ Urgent vs important:

Most expenses, which look urgent, are perhaps not so important — the shirt or shoe at a sale. That luxury item which was being offered at 30 per cent discount is such an example. These small leakages are all reducing the amount of money you will have for the bigger things like education or retirement.

➡ Focusing too much on money:

Money is no longer a commodity to buy things. It is a scorecard of one’s life. That will cause stress, and yoga might help. However if you will seek a branded yoga teacher — so that your friends think you have arrived, yoga it self could cause financial stress!

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There are many reasons why you need to plan. Let us enumerate some of them:

  1. To protect you and your family against financial risks: Financial risks include early death, critical illness, accidents reducing your ability to earn, living too long, etc.
  2. To reduce or eliminate personal debt: Too many people spend with money that they are yet to earn! This will ensure an unnaturally high pressure on their future cash flows. So learn to pare the debt that you have. One major worry about debt is the high cost at which it is made available to you. In case you take a loan from a bank on your credit card, you will end up paying more than 40% as interest. You get the hang of what I am saying…!
  3. You will live too long: Much longer than you think you will! The associated costs of living will have to be taken care of. If you are a gymnast you would have retired at 15 years, a tennis player at 32, a cricketer at 35, or just an ordinary employee in a 9 to 5 job then at 58 years. Now if you live up till the age of 90 – or your spouse (who is 5 years younger to you) lives up till the age of 90 (i.e. your age of 95 years), have you estimated how much money you will need.
  4. What about multiple careers and multiple marriages: Somebody has to pay for re-tooling and the waiting to “earn” periods! If we want American salaries, let us get ready for American uncertainties too!
  5. Cost of raising kids:  Well that should be a separate chapter at least, if not a separate book! A good schooling, good college and perhaps a foreign education will totally cost you in 8 digits for sure. How ready are you for this?
  6. You may not understand all the risks that you run in your life and in your journey towards your goals. Buying risk cover is a mine field! So you need a decent choice and this can come only from knowledge. In fact this should have been the first step. The most important benefit of financial planning is that your ability to understand finance, finance products, etc. should go up substantially!
  7. For all the assets that you will buy in life: Well we will continue to call a house, a car, a trip to Europe, a nice golf kit, etc. assets, so what if Robert Kiyosaki thinks otherwise!
  8. To be able to retire: When and in a style that you want to. You do not want to be at the mercy of your kids, do you? So creating enough money to help you in your “old age” (that means you, even if you do not like the expression) is an important goal of financial planning.
  9. To pay for long term care: From a home maid to a nurse or aided living all of this will cost a lot of money. Your medical insurance has its limitation! Your financial plan should keep all this in mind.
  10. In case you wish to leave some money for your kids after your death: Then this should be a part of your financial plan too. Though not obligatory most parents would want this to happen if they can help it. So if you wish to leave some money for your kids (or grand kids) you need to do some good financial planning.

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Shiva Garru of Hyderabad told me a story really difficult to believe, amusing for the readers and sad for the participant.

His father in law had invested in fixed deposits and lost money, where as his father had a lot of money in equity shares of Satyam and lost money. So Shiva concluded that investing is risky. In fact he was a little excited and said investing with ‘Raju’ is risky! I explained to him that not investing is equally risky – risk of inflation too! Let us cut to the story.

Shiva’s father-in-law had kept almost all his money in Nagarjuna group’s fixed deposit and had by now lost all hopes of getting it back from the company.

I reminded him the story of the 3 pigs and a wolf. There were 3 pigs that needed to build a house for themselves.

A house is supposed to protect you from the vagaries of nature and make you feel safe, right? The first pig built a house of straw. The wolf came – huffed, puffed and the ‘house’ came down. The wolf got the pig for dinner.

The second pig built a house of wood. The wolf came, huffed, puffed and the house came down. The wolf got the pig for dinner, again!

The third pig realized that the problem was not in the quality of material used in the construction, but in the enemy – the wolf! So he constructed a house of stone and cement and invited the wolf through the chimney.

He had kept a pot of boiling water at the fire place and made sure that the wolf was killed. GETTING RID OF RISK / MANAGING THE RISK is what the 3rd pig did. Similar is the investment story. The risk for Shiva’s father and father in law did not come from the Rajus! It came from their own understanding of risk. That is exactly what Warren Buffet says. Risk comes from ‘not knowing’ what you are doing.

If all investors know their own financial goals, risk profile, understand their severe limitations in stock picking, accept that portfolio construction cannot be learnt by watching television or ‘googling’ they will become better investors. If you cannot beat the index while investing on your own (like how most of our fund managers cannot), just put your equity portion in an equity index fund, a portion of your short term debt allocation in an income fund, a gold etf, and in government schemes for longer term debt.

You will do far better than many fund mangers. While investing it is all right if the world thinks you are a pig – remember the third pig lived to tell the tale!

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