PERSONAL FINANCE 101: How to effectively manage your salary

The challenges of the first job: impress the boss, navigating through office politics, making sure not to make stupid mistakes, trying to make good first impressions, being on time and the list goes on and on. All for just one thing- a paycheck. Earning a paycheck sure is difficult but managing it is an all-together separate ball-game, and mind you, it sounds easy but it actually isn’t. A comfy salary or a monetary cushion often lulls people into overlooking their financial future

It’s easy sailing in the early years, when you have no additional responsibilities, knowing that you have support from your parents. However, it becomes difficult when circumstances change, which they definitely will in the future. . Managing your money is not as hard as earning it, but a little effort and planning can be really fruitful in the long run. All it takes is a small, mindful plan and disciplined execution. You don’t have to be a financial planner or even a business graduate to know about financial planning. At the core of it, personal finance is just simple logic-based planning, albeit sometimes it requires the help of a certified financial planner otherwise, with a little bit of research and effort, you are good on your own.

Here are a few tips from my side that you can embrace in order to manage your salary effectively.

1. Limit your EMIs: The worst financial mistakes you can do is excessive purchases through EMI. You might feel like you can buy anything and everything you want without actually paying for it, but this habit might soon lead you to a debt trap and thus you should strictly avoid it. Limit EMIs only to essential expenditures like for your housing loans, not for buying smartphones or even furniture. Purchases should be made from your previous earnings, i.e. money that you have saved, but paying through EMIs means that you are buying stuff out of your future income. There’s no bigger mistake you can make than this. The first and foremost task is to stop buying things through EMIs. In the field of personal finance, unnecessarily taking debt is a cardinal sin.
2. Watch your expenses: Without sugar coating anything, you have to be frugal. Now, here I do not mean that you should stop going to dinners with your friends or switch to cheaper quality food items, rather I mean cutting down unnecessary and callous expenditures. Being thrifty and prudent helps to save a lot of money that can be saved or invested. Being thrifty means buying clothes from Westside and not Zara, or going out to eat at a regular restaurant rather than a flashy, 5-star. Nowadays, it's even easier to fall for corporate marketing gimmicks and buy products and use services we don’t need. So it becomes even more imperative to keep a check on our expenditures and train ourselves to become financially prudent.
3. Build an emergency fund: Probably one of the most important of all tips that I can give you. And what is the best time other than experiencing the Covid imposed lockdowns worldwide. Job losses, giant pay cuts, zilch bonuses, and tremendous uncertainty. How would one have survived without any savings? For other emergencies, most important health and also in case you lose your job, your savings are the only cushion you have, otherwise, how will you pay off your bills, they would never stop. Ideally, saving six months' worth of living expenses would suffice, but if the figure is too daunting, three-four months of expenses should also serve the purpose but gradually you should start contributing more to this fund until you reach your desired amount. Another thing to keep in mind is that you are building this fund for emergency purposes only, so it should only and definitely be used only for emergencies. You might very easily feel the urge to use some of the money out of this corpus for an international trip or to buy something else, but be stern with yourself and do not use it for any other purpose than it was intended for. Also, since this fund is for “emergencies only” keep this fund in highly liquid form, meaning you can withdraw it with ease whenever you wish and at the right market price, meaning putting it in a bank account or a liquid mutual fund (hard cash not recommended.
4. Clearly define your financial goals (Both short-term and long-term): For financial purposes, and even otherwise in life, it's super important to define your future goals. These include your child’s education or marriage, buying a car, or making a big purchase such as your own home. And these targets should be time-specific meaning that, say for instance “I want to buy my own home in the next 15 years” which is a long-term goal. On the other hand, a short-term goal will be like “I want to send my child to college after he graduates school in the next 3 years” and an even shorter-term goal can be “I want to go on an international trip next year.” Clearly defining your own goals helps you save accordingly and also invest accordingly. If you know that a big expense is coming up next year, you’ll start liquidating your investments from now on, or if you know that currently you don’t need this money or you have excess savings you can invest in investments in different maturities as per your financial goals. For instance, if you know that you will need to pay for your child’s college tuition fee in the next 12–15 years, so accordingly you can make investments in a risk-free provident fund account whose maturity is 15 years or in blue-chip equity mutual funds. Another example is that if you plan to purchase a new home in the next 5 years, you know that you’ll need to make a hefty down payment, so you can deposit money in a post office recurring deposit for 5 years and periodically deposit money into that account. You can only plan such investments when you know what you plan to do and when to do it.
5. Invest: First and foremost, putting money in a bank fixed deposit is not investing. Apart from building an emergency fund, investing your savings is another extremely important, almost a necessity. Idle money generates no return, let money work for you. A plethora of investment products might make one a little anxious therefore if you have no prior experience in investing or have no idea what stocks or bonds are, I advise you to let your financial advisor make this decision for you. If you don’t want to hire a financial advisor, here is a quick guide from my side to make correct long investment decisions that you won’t regret in the future: Know your R.R.T.T.L.L.U.s

a) Risk- Firstly, know your risk appetite. How much risk are you willing to tolerate. Risk broadly depends on your ability to tolerate risk and your willingness to tolerate risk. The ability to bear risk is the function of a variety of factors such as additional responsibilities you bear such as dependent parents or child’s education, the stability of your paycheck, current state of the economy, etc. Willingness to bear risk is a function of your personality type i.e. whether you are able to bear the ups and downs of the market cycles and are determined enough to stay invested irrespective of market conditions. Also, one needs to balance the risk he/she is willing to take with the risk exposure for optimal portfolio performance.

b) Return- The return objective needs to be balanced with your risk objectives. You cannot earn returns commensurate with equities while investing in fixed income. Risk and return always work in direct proportion. So bear in mind in order to earn a higher return you need to take on risk but it does not work the other way, meaning that taking on a higher risk will not necessarily earn a higher return.

c) Tax- Through smart investing, one can very easily save on tax and in some cases even pay no tax. Nowadays, both equity and fixed income investment products come with tax exemptions along with post office savings and retirement schemes, so it serves the purpose for all investors with varied risk tolerance. If you want to invest in equities, a new investment product named “Equity Linked Saving Scheme(ELSS)” provides tax savings on investments up to Rs.1,50,000 with returns similar to other equity mutual funds, so it comes with high risk, however, it requires a lock-in of 3 years and returns are taxable. For fixed-income investors, one can invest in tax-exempt sovereign and non-sovereign bonds. There are also evergreen and ever-so-popular post office retirement and savings namely “Public Provident Fund(PPF), Kisan Vikas Patra(KVP), National Pension Scheme(NPS), Sukanya Samridhi Yojana(SSY)” and many more. Most of these come with 3E exemption- meaning that the investment amount helps in tax saving, the return is tax-exempt and the principal returned at maturity is also tax-exempt. All the mentioned schemes are guaranteed by the government of India so they are virtually default risk-free.

d) Time Horizon- Your time horizon for investment also affects your risk and return objectives and also your decision to invest in which asset class. Longer time to horizon means a higher risk but naturally, you would require greater compensation for deferring your consumption, more chances of big movements in asset prices, so more volatility in markets, greater chances that a company might default, and more instability in your portfolio due to movements in interest rates. Longer time horizon investments should be made in equities followed by fixed income for medium-term investments and short term can be made in fixed income mutual funds. Gold is a good investment if you want a hedge against inflation and want the safety of your portfolio during market crashes.

e)Liquidity- Liquidity means two things- the ease with which assets can be converted into cash and secondly, converting them at their fair market value. It simply means that if you have a piece of land, how long would it take you to sell it and at what price. If it takes me a month more than a normal real estate transaction, then the asset is not liquid. Secondly, anyone will buy land worth Rs.50,00,000 for Rs.45,00,000 so if it takes you a week to do this transaction still the asset is not liquid as you didn’t sell it at its fair market value. An illiquidity premium is attached to assets that do not meet the above-mentioned criteria and so these assets will sell at a price less than their liquid counterparts.

f) Legal Constraints- One should also take into consideration all the legal constraints that might restrict the investor from investing in a particular asset class or security. These also include regulatory constraints and other restrictions.

g)Unique Circumstances- These circumstances are highly bespoke and personal and therefore depend on person-to-person. For example, one would not want to invest in companies that run casinos or are into tobacco or alcohol. Such unique circumstances often alter the risk and return profiles of investors and should be kept in mind while making investment decisions.

Here are a few bonus tips from my side that I feel are very important to be kept in mind while making investment decisions. These tips generally do not strike a person who is new to investing but can be tremendously practical:

1. BUY GOLD- Gold might not sound like a very alluring investment option but it is highly recommended for extreme risk-averse investors. Gold values have been very stable in the past, they exhibit very little volatility and are an excellent hedge against inflation. It is also negatively correlated with most of the major asset classes like equities and bonds and thus can be a good source of return in times of market crashes. It is also a great store of value and nowadays there are a plethora of ways in which one can invest in gold.
2. DON’T BUY STOCK OF YOUR EMPLOYER- Buying the stock of your employer isn’t very highly recommended. Accepting ESOPs is satisfactory because you have no alternative and plus it's a part of your compensation plan. On the other hand, buying stock or even bonds of the company you work in not a prudent decision as if for instance your employer goes bankrupt, you’ll lose your job and at the same time make losses on your investment.
3. COMMODITIES AS HEDGE AGAINST INFLATION- Similar to gold, commodities are not known for generating high returns in the long run however they are the ultimate hedge against inflation. So if you do not have exposure to floating rate bonds (which you most certainly won’t have in your portfolio), I recommend buying commodities mutual funds/ETFs or buy shares of commodity-centric companies.
4. DON’T BE TOO FANCY- Finally, the most important advice that I can give you is don’t be fancy and to keep it simple. There are a lot of exotic and cool-sounding investment products, but you don’t need them. Nobody actually needs them, they are just a part of our consumeristic lifestyle where we like the fanciest and weird-looking products the most. Investing in international funds, or buying digital options, or buying structured products should be left to investment banks and hedge funds. They are being offered to retail clients with the sole purpose of generating commissions and offering a much more liquid market to the transaction counterparty, which is the investment bank themselves. These fancy investments are a product of capitalism and the never-ending yearning for corporate profits. Retails investors should understand that traditional investment products have huge potential and never fail to disappoint and never will. Prudently and smartly investing in equities and bonds with thorough research will give much better results than these synthetic investment products that claim to be better and more tech-enabled but in reality, are superfluous and misleading.
5. STAY AWAY FROM BITCOIN AND OTHER CRYPTOS- An early investor gets drawn towards bitcoin like a child towards candy. I know it is very hard to resist the temptation of investing in bitcoin and other cryptocurrencies like ethereum, monero or ripple after you realize that it went up 10% in a single day. Let fancy hedge funds for publicity and hipsters for being quirky invest in bitcoin. According to me, a rational investor shouldn’t even think of investing in bitcoin considering its volatility and petty float and with how simplicity and relative ease one can manipulate its price via transaction-based or information-based manipulation. Getting enticed by just returns that are neither sustainable nor viable is not a prudent choice, ergo one should not view bitcoin and cryptocurrencies as an investment vehicle or as an asset class.