This article is part of the series – Check your financial IQ. The aim of the series is to put together thoughts and practices that lead to better financial health. No matter how much money you earn, if you don’t have the financial IQ to handle the money, your wealth is not going to reach its full potential. Worse, your wealth could be actually diminishing every day if handled poorly. So education on personal finance is very important and if done right, it will lead to sustainable prosperity that many people crave.
Are you becoming wealthier?
Who doesn’t want to be wealthy? Although the definition of wealthy varies from person to person, we all want our money to grow. However, it is very important to understand whether or not our wealth and net worth is actually growing. If yes, is it really growing enough to satisfy our future needs? Bifurcating your money based on future needs and contingencies is an art, which I can possibly cover in another article. For now, let’s focus on the basics.
Are you regularly saving a part of your income?
This one is obvious that if we add more savings to our existing wealth, it is expected to grow. We have also heard it a thousand times from well-wishers to consistently save a part of our income. How much should you save? Well, it is a common suggestion to save at least 10% of your income. More the better of course. Still, there is a huge number of individuals who live paycheck to paycheck and have meager or NIL savings. One of the common excuses is – I have a small income and can hardly manage the living expenses. Another one is – My credit card bills eat up most of my salary. These are signs of poor money management. Trust me, no matter how large your income is, expenses always fill up to match or exceed the income. In that case, you should reverse the cycle. Take aside 10% of your income on the first day and then use the remaining for your expenses. It may seem difficult but you will be surprised how well it works. For credit card users, there is an important catch. You should always make the payment in full instead of the minimum required. The first priority should be to clear off the credit card debt otherwise you will end up in a vicious cycle.
Another important factor is how early you start the habit of savings. There is a huge benefit to being an early bird here and the end result is more dramatic than you could probably imagine. Take an example of two people with the same salary, career growth, and savings with just one difference that one started the habit of savings a bit early. I have taken INR as an example but obviously, currency doesn’t matter.
Person 1
Starting monthly salary at age 20 = ₹ 50,000
Monthly savings = 10%
Yearly salary increment = 5%
Started savings at age = 20
Person 2
Starting monthly salary at age 20 = ₹ 50,000
Monthly savings = 10%
Yearly salary increment = 5%
Started savings at age = 30
Let’s assume both invest their savings at a modest 6% return. After retirement at 60, here is how their corpus looks like
| Person 1 corpus: | ₹ 2,06,80,629 |
| Person 2 corpus: | ₹ 90,27,489 |
Other than the fact that the first person has accumulated a handsome wealth (2 crores), it is more than double the amount saved by the other person who only realized the importance of saving just a bit later in life.
What is the real growth rate of your wealth?
If you got over-excited looking at the figure of 2 crores at retirement, hold your horses. You might have heard of schemes promising 1 crore (₹1,00,00,000) of sum at retirement (let’s say after 30 years) with a small monthly investment. While they may not be a scam per se, they are trying to over-sell the returns, prying on the uninformed. This is because of a very important factor in the equation – inflation. What is inflation? It is the decline in purchasing power of money over time. Simply put, things get expensive year on year because of inflation. Because of this, a sum of 1 crore after 30 years might not be as lucrative as you might think. So how much worth is your retirement money? Assuming an inflation rate of 6%, 1 crore after 30 years is really worth only 17 lakh. So, if you thought of buying a lavish house to grow old in, you need to either set the expectations right or be smart with your investments.
Inflation has a very important implication on whether your money is actually growing. Suppose you have put a large portion of your savings in a bank account that pays 4% interest when the inflation rate is 5%. In this case, you are actually losing money every day. This is why it is important to beat inflation in order to actually grow the value of your wealth.
Due to the same reason, you have to be careful with the retirement planning as well. If you invest in a scheme that promises ₹50,000 per month of pension after retirement, you might think that your future is sorted but only to realize at the time that it is hardly enough for groceries. And this is assuming that the scheme actually delivers on its promise.
I hope you liked the article. I plan to write a series of articles on personal finance ranging from basic to advanced. Feel free to let me know in the comments for any suggestions.
Important Disclaimer: I am not a financial advisor and the information and resources on this website should not be construed as financial advice. While I have tried my best to provide meaningful information as accurately as possible, use your own judgment or take the help of a professional who can advise based on your particular needs and situation.