Money Management: The Art & Science Of Wealth Creation

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Money needs planning. If not planned well, money evaporates into the thin air without a trace. Have you ever wondered how rich people manage their high life and high expense? How do they afford to drive swanky cars, enjoy foreign vacations and yet manage to repeat it over and over again? They earn a lot of money, you would say. That's true, but only partially. The answer is - financial planning. Smart people earn big and they go on to make it bigger with their astute money management skills. Disciplined spending and intelligent investments are the two critical factors for wealth creation.

Now you may say, financial planning and money management are the things rich and famous folks need. Not true. On the contrary, working professionals, whether they belong to the middle class, upper middle or lower class need to have a well thought out plan for spendings and investment. This simple activity is called money management.

What Is Money Management And Why Is It Important?

The copybook definition of money management is that it is a process of budgeting, saving, spending and investing in and utilising the capital of an individual or group. Money management is like wealth management but on a smaller scale. Wealth management is a service for people who have considerable wealth. On the other hand, money management is for those who have any money in the form of salary, business profit, pension, etc. It's the process to give your money the value it deserves.

In financial markets, the work professional financial advisors do i.e taking investment decisions for their clients, advising them on mutual funds, pension plans are considered as services of money management. Investment management and portfolio management is also sometimes referred to as money management.

Why Is It Important?

Every individual has dreams and aspirations. To bring these dreams into reality you need money. This is the point where money management comes into the picture. Money management is the process of money management to meet your life goals. These life goals can be categorised into short-term and long-term goals. Buying a house, saving for your child's higher education or planning for retirement are long-term goals while planning a family vacation and buying a car are short-term goals. It's a step by step process that helps you understand where you are currently and also helps you determine where you want to be and what you need to do to be there. Some of the important aspects of this process involve gathering relevant financial information, establishing life goals, reviewing your current financial status and drawing a strategy for how you can meet your goals.

Does that sound too bookish? Let's try to understand the concept through an example.

Ram is a working professional in his mid-30s. He earns Rs.50,000 every month. But Ram is an ambitious person, he wants to live a good life studded with comfort and luxury at the same time he is worried about his retirement savings. To find a golden middle to this dilemma he approaches a financial planner who chalks out an investment as well as spending plan for Ram. According to the plan, Ram has to buy a term insurance to secure his family's future from the unforeseen events of the future. Second, Ram has to start two systematic Investment Plans (SIPs) to meet his short-term goal of buying a car and the long-term goal of saving for his retirement.

If Ram is disciplined in his investment in the next 4-5 years he would be able to buy a new car and he will also be well on the way to build a handsome retirement corpus.

This example broadly outlines the core of financial planning, as we go forward you will get to understand all the important aspects in a greater detail.

Key Components Of Money Management

As mentioned above financial planning is a step-by-step process of streamlining your spending and investment. It's objective is to give a direction to your money and to prevent money spillages.

Here are some of the critical elements:

Income & Expenditure - The first and foremost step is to take stock of your income. How much money you earn from your job and alternate professions i.e. freelance assignments or side business, etc. The next step is to take account of the expenditure. Review all your spendings, check if there are any unnecessary spendings on the regular basis. If yes, prevent it from happening. This exercise will give you a clear view of how much money you need on the monthly basis, how much cash flow you need, how much surplus money you get, etc.

Increased Cash Flow- If you start watching your spendings closely there is a fair chance that you will locate various unnecessary expenses. As a result of you preventing them from happening, your cash flow will increase. This is a positive sign that your money management is working. Having more cash flow allows you to either invest more or to reduce debt. Besides, a healthy cash flow is a sign of healthy financials.

Health & Life Insurance - Never make the mistake of confusing insurance with investment. These are two different things meant for different objectives. In money management, insurance plays an important role. You have to ideally get two insurance covers i.e. medical/health insurance for your family and a term insurance for yourself. Medical/Health insurance helps you in medical emergencies while term insurance provides a life cover with a significant amount. Spending money on insurance is a wise thing. It gives you the much-needed cover from the uncertainties of the future. However, one should be careful of how much to spend on insurance. There are various web portals which provide the service of comparing the insurance policies. Remember, choosing the cheapest plan is not the objective but to find a plan which will be cost-efficient at the same time has a good claim settlement percentage and service.

Investment - The most important aspect. Investment in the right instruments on a regular and long-term basis can do wonders for your life. The cycle of financial planning comes to full circle in the investment part. Thus this part needs to dealt with utmost caution. Further, in this article, we will discuss ideal investment instruments to meet your short-term as well as long-term goals.

Debt Management- Debt is a necessary evil. Every working professional, at some point in his/her life, has to take a loan. But if it is not managed properly it can become a big roadblock in your financial planning. At a planning stage, it is important that you should review all your debts and make a systematic payment plan to reduce it as early as possible. Loans like personal loans have high interest. If you default these payments you incur additional charges which further disturb your cash flow. Thus it is imperative to aim to remove the debt burden by regular and disciplined payment of EMIs. A home loan can be seen as an exception as it is a capital expense and also helps to save the income tax.

Investment Instruments That Complement Your Life Goals

As we discussed above your life goals should be aligned in two broad categories - short-term and long-term. Once you have ascertained your goals it is incumbent upon you to choose right investment instruments and start investing for the same. Selection of investment instruments should be done with great caution. A mistake here not only causes loss of money but a loss of time which is equally important in investment planning. Let's take a look at the ideal investment mediums for all your life goals.

Children's Education - This is a long-term goal so you get a plenty of time to invest for this goal and also get to reap the benefits of compounding. The ideal investment instrument for this goal would be equity mutual fund. Historical data suggest that equity has given best returns in the long run. The amount of SIP or lump sum amount depends on how much money you need. You also have to factor in growing inflation to ascertain actual amount.

Buying A New Car - This is a short-term goal. There are two ways you can go about accomplishing your goal - you can either get a car loan or you can start saving for a couple of years. You can choose the option that works best for you but should you choose the second options then the best investment option is balanced fund. The balanced fund is also known as a hybrid fund. Balanced funds invest your money in equity as well as in the debt market. This way you get the best of both worlds - you get high returns through equity and safety via debt.

Retirement Planning - This is an extremely long-term objective. If you start investing for your retirement in your 30s you still get around 25 to 30 years to accomplish your goal. The reason we call retirement planning the cornerstone of financial planning is that you have to think from all the angles and consider all the possibilities while planning. For building retirement corpus you can't rely on just one investment medium. As it is a long-term goal equity will play a crucial role. You can start a SIP in equity mutual funds which you have to keep upgrading periodically. You can look at government schemes like Public Provident Funds (PPF) and National Pension Schemes (NPS) for tax benefits. There is also an option of direct equity investment (Stock Market) where if you have a long-term vision you can get great rewards. However, if you are not well versed in the working of the stock market then instead of looking for free stock market tips you should either opt for services like portfolio management service or stock advisory firms to reduce the risk factor.

Role Of Equity In Money Management

If financial planning is a film, equity is the hero of that film. It plays an extremely crucial role in accomplishing your life goals. Amongst all the asset classes, equity will always be the most rewarding. However, you have to bear one important thing in your mind that equity investment has a high-risk proposition. If not done cautiously, there are always chances that your equity investment will backfire. At this point let's focus on how you can benefit from equity.

You can invest in equity via two routes - direct equity investment and mutual fund. If you have a demat account and have the working knowledge of stock market then you can opt for direct equity investment. It poses a big risk but it offers uncapped growth. Yes, there is absolutely no ceiling on how much returns you can get if you invest in the right stocks on the long-term basis. If you don't have enough knowledge of stock market you can avail services like portfolio management service or get help from a stock advisory firms like Niveza.

If you want to take a safer route then equity mutual fund is your best option. All you need to do is find the right fund, start a SIP and keep investing in a disciplined manner for a long, long time. The longer you stay invested the better benefits of compounding you get.

Whatever your route may be, it goes without saying that to get sterling returns there is no alternative to equity investment.

What's Best? Do It Yourself Or Seek Professional Help?

Financial planning is not just about adding and subtracting numbers. It's a complex affair where aspects like the nation's inflation and global inflation, tax provisions, contingency plans for equity investment and risk management have to be considered. Sounds confusing? Indeed this is a work of a professional. If you don't have adequate knowledge to chalk out a comprehensive financial plan for yourself, your best foot forward is to get help from a certified financial planner. The professional planners are well-equipped with all the knowledge of investment and tax saving and risk management. Moreover, the biggest reason one has to get an expert on board is that like clothes, financial plans have to be made to size. Every individual has to have a customised plan to suit his/her requirements. Hence, it's a no-brainer that you are better off under the guidance of professional financial planners.