Principles of Money Management

If you haven’t checked my previous post on Personal Finance, please follow the link.

The basic principles of Money Management are as follows,

Spend less than your earnings

One may wonder “Is it possible to spend more than one’s earnings”?

Yes. Because of availability of easy finance options, one can easily be prompted to spend more and if it exceeds the bearable limit, he might land in trouble.

Instead of buying some non-essential items on finance and paying on EMI, I would suggest the people to set aside that EMI for a few months and get accustomed to savings habit and then buy it with ready cash if at all they feel it is unavoidable. People just need a little bit of patience.

If one could do this, then he will be able to continue to save the same amount even after purchasing that item and accumulate funds for future use. In this way, one can limit his expenses, create surplus and use it for accumulating or creating assets.

Budget your expenses

Budgeting is the first step in the financial planning process. Budgeting is nothing but recording your income and expenses and only this process can tell you where you stand financially.

After budgeting, if one finds surplus at the end of the month, it can be used for savings and investments for the future goals. Otherwise, if one ends up with deficit at the end of the month, there will be an opportunity to revisit the expenses and ensure that the previous month’s spending was in order and were on essential things.

If any non-essential spending is identified in the recorded expenses, the same can be avoided in subsequent months to try to generate surplus. Creating or generating surplus is the expected outcome of practicing the process of budgeting.

Create Emergency Fund

Emergency Fund shall be created with the help of a part of the surplus we generated through budgeting practice but the habit of creating emergency fund is uncommon among our people. Any one, rich or middle class, may be in need of urgent cash at any time in their life. Middle class people’s need will be in the range of ₹ 50,000/- and ₹ 1,00,000/- and HNI’s need will be in the range of ₹ 50,00,000/- to ₹ 1 Crore. That is only the difference.

Without emergency fund, it would be tough for the people to manage their emergency cash need. And when one such condition arises, they use 3 options.

  • Look for a debt from a friend or relative

  • Apply for a personal loan or use credit card

  • Use the gold in the house and mortgage it for instant cash

Instead, a small portion of our earnings shall be set aside and accumulated to reach 3 to 6 times the monthly expenses as emergency fund in any of the liquid assets. Liquid assets are those which can be converted to cash within a short span of time without losing its value. Some of the suggested liquid assets are cash in hand, balance in SB account, Liquid funds in MF and FD’s with less than or equal to 1 year tenure.

Emergency fund would be right solution for the current situation like COVID-19 where people lost their income temporarily or partially. But it cannot be the solution for the permanent loss of income due to uncertainties. There is a solution for the permanent loss of income problem which we shall discuss in the upcoming posts.

Savings and Investments

There is a huge difference between savings and investments and there are separate financial products for the purpose of savings as well as investments. People should understand the difference between the two before making a decision.

The financial products meant for savings should be used for short term goals only because if used for long term goals, then the risk of inflation is inevitable and will fall short of the need.

Similarly, the financial products meant for investments (Equity oriented products) should be used for long term goals. If it is used for short term goals, then people may face the risk of capital loss or capital erosion at the time of redemption or face the liquidity issues.

Some of the products to be used for short term savings purpose are SB Account, Liquid Funds and ultra-short-term funds, short term RD and so on. Whereas for long term investments one can make use of Stocks, Mutual Funds, PPF and Insurance products.

In the next communication, we shall discuss on assessing and analyzing the financial fitness of an individual or a business organization.

Thank you!!

About the author

Karunanidhi Marudhachalam

Chartered Financial Practitioner

Chief Life Insurance Advisor - LIC Of India