SERVE WHAT YOU LEARNT

How to manage your money?

This guide is mainly written for young people. Boys and girls, who just start earning know little about tax, mutual funds, PPF etc. However, it can still be used by people who already know about money management too. It covers all the basics in an easy to understand, simplified way!

If you know someone who has just started earning and will find this information useful, please do recommend it to them.


Introduction



This guide is a little sad! When you get your first salary, the last thing on your mind is “investing” and “tax” and other such issues. You probably want to use your salary to buy yourself something or spend the money on entertainment, watching movies, partying etc. However, this guide is going to tell you that you need to manage your money. You can enjoy yourself, but you also need to save and invest and use your money properly. So I guess the obvious question is...

Why should you invest?
You will not have to work!

You probably have heard the phrase “Let your money work for you!”. Just incase you do not understand what exactly this means, let us explain. The whole idea of investing is that you create or buy an “asset”.

What is an asset?

An “asset” is something that generates money. Just to give you an example, if you buy a flat for 4 lakh and then rent it out for Rs.3000 a month then you have created an asset. An “asset” that generates Rs.3000 a month.

However, this is just one type of asset. Assets are of many kinds. If you have a “copyright” or patent in your name, for which you get paid a certain amount when anybody uses it, then that too is called an asset. If you own a small pay phone from which you make just Rs.20 each day, then that too is called an asset!

The above given explanation is very crude, but that is the basics of investing. You want to invest the money you make in assets. Assets that generate money. The idea is that once you invest your money in enough assets, you can stop working. All your assets will make money for you. You can then use this money to enjoy life. Or you can use this money to invest in more assets that generate more money! So all this gives us the phrase, “Let your money work for you!” This is the main aim of investing. However, there are many other smaller aims of investing and we have explained them to you next...
Investing for making the "big buys!"

If you are not married yet, then sooner or later you are probably going to get married. After that you will probably going to go in for a house. After that you will probably go in for a vehicle. Then you might want to go for a long vacation. Then you might want to buy a buy a bigger house. Then you might fall sick and have a big operation.

Why are we saying all this? These are events that occur in almost everyone’s lives. All of them are “big buys”! They take up a huge amount of money. If after a few years you randomly decide to do one of these things, then arranging the money for this suddenly will be a problem. If you have a salary of Rs.10-20 thousand and you have to arrange for Rs.2.5 lakh next month, then will you be able to do so? Probably not.

You might say, that now-a-days, loans are easily available. I will just take a loan! I will just buy on credit! BAAAAD IDEAA!! BAD IDEA!!!!

Why is taking a loan a bad idea?

Obvious reason: Assume you have to make a “big buy” of Rs.15 lakh (Like a house etc.) Now, when you take a loan for making the purchase, you will not only have to pay the Rs.15 lakh. You will also have to pay the interest. So you might end up paying Rs.18 lakh for something that actually costs you Rs.15 lakh. 3 lakh more!!!!

If for some reason you think that 3 lakh is a small amount and it is okay to waste it, think not only about the 3 lakh. Think about the earning power of the 3 lakh. The 3 lakh can be invested in an asset that makes around Rs.2,000 each month!

If you told you, “Would you like an extra Rs.2,000 each month for free, for doing nothing?” what will you say? I bet most people will not throw it away. Then why throw away 3 lakh?

Besides this, the other problem with credit is that once you buy something on credit, you get into to habit of taking a lot of things on credit. Now, this point is a little hard to appreciate. However, there are a lot of people out there who get into the habit of buying everything on credit because credit makes it so easy for you to buy things. People love the “Buy now. Pay Later!” idea. They get hooked to it.

There are people who buy a big house, a big car, a big T.V. etc. all on credit. Because of this, they have to pay their monthly installments for all these items and their monthly installments alone take up half of their salary. The rest of their salary, is taken away by basic things like food and other necessities. If any part of the salary remains it goes into the maintenance of the big TV, big house or the fuel for the big car.

These people can forget about investing and creating assets. They live a hand-to-mouth existence. If for some reason they loose their job, or fall ill and are unable to work, then they will not be in the position to pay their monthly installments and all their big T.V., big car, big house etc. will be taken away from them. In case they expire, they leave the credit burden for their family to bare!

So, do you want to live this way? If you do not then “good financial planning” and “good investing” is the key! In case you forgot the original pint, you need to invest so that you can make the “big buys” that you need to make!
Investing for TAX SAVING!

The major reason why a large number of young people invest is to save tax! In fact, thank God for tax. If tax did not exist, the youth would never even think about investing!

Incase you do not know how this whole “tax saving” and investing thing works, let us explain that first.

You see the Govt. wants us to invest in certain things. Some of the things that the Govt. wants us to invest in are for our own good. The other things are for the good of the nation. So to encourage people to invest their money in the “these things” the Govt. says that, “If you invest your money in these things, you do not have to pay ‘income tax’ for earning that money!”

Incase you are confused, I will just give you are very basic and crude explanation on how income tax is calculated and paid. You see, “income tax” is all about your “income” i.e. the money you earn! You have to basically pay a portion of what you earn to the Govt.

Suppose you do a job and you earn Rs.20,000 every month you will have to pay a part or a “percentage” of that money to the Govt. What is the percentage that you have to pay? That depends on the “tax bracket” you fall in.

What is a tax bracket? You see, the Govt. feels that rich people can afford to give more money towards the development of the country and poor people cannot give much. Also the really poor people cannot give anything at all since they are struggling financially. So the Govt. has decided whether you are “very poor” or “poor” or “rich” or “very rich” depending on how much income you make. If you fall in the “very rich” category than you have to pay a big percentage of your money towards the county. If you fall in the “very poor” category you do not have to pay anything to the country.

This is basically what tax brackets are. The Govt. has decided what percentage of your income you must pay as “income tax” depending on how much you make or which “tax bracket” you fall in.

Now there is a legal way of paying less tax than what you are supposed to pay. And this way is though “investments”. If you invest part of your income into Govt. bonds, infrastructure bonds, life insurance etc. then your income will reduce and you will have to pay less to the Govt though income tax!

However, this is not true for any type of investment. It is true only for certain types of investments as stated by the Govt. Also, if you invest your money in these tax saving things, it does not just “go away”! You actually create an asset. An asset that produces money for your self. So, instead of loosing the earning power of the money by giving it to the Govt. though income tax, you could use the money to create an asset and also save tax in the process.

Again, incase you lost the original point in all the explanation, invest your money to save tax!

What we have told you above, are just the very basics of saving tax. There is a lot more to learn! If you are interested, we suggest you read the book "How to save income tax though tax planning?". You can get yourself the book from ebay.in

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Inflation..and how it eats your money!

Inflation is an economic concept. What the cause of inflation is, is not important to us from the point of view of this article. What is important to us is the effect of inflation!

The effect of inflation is the prices of everything going up over the years. A movie ticket was for a few paise in my dad’s time. Now it is worth Rs.50. My dads first salary for the month was Rs.400 and over he years it has now become Rs.75,000. This is what inflation is, the price of everything goes up. Because the price goes up, the salaries go up.

If you really think about it, inflation makes the worth of money reduce. What you could buy in my dad’s time for Rs.10, now a days you will not be able to buy for Rs.400 also. The worth of money has reduced! If this is still not clear consider this, when my father was a kid, he used to get 50paise pocket money. He used to use this money to go and watch a movie (At that time you could watch a movie for 50paise!)

Now, just for the sake of understanding assume that my dad decided in his childhood to save 50paise thinking, that one day when he becomes big, he will go for a movie. Many years pass. The year now is 2006. My dad goes to the theater and asks for a ticket. He offers the ticket booth guy at the theater 50paise and asks for a ticket. The ticket booth guy says, “I am sorry sir, the ticket is worth Rs.50. You will not be able to even buy a “paw wada” with the 50paise!!”

The moral of the story is that, the worth of the 50paise reduced dramatically. 50paise could buy a whole lot when my dad was a kid. Now 50paise can buy nothing. This is inflation.

What does this tell us?

Do not keep your money stagnant. If you just save money by putting it your safe it will loose value over time. If you have Rs.1000 in your safe today and you keep it there for 10years or so, it will be worth a lot less after 10 years. If you can buy something for Rs.1000 today, you will probably require Rs.1500 to buy it 10 years from now. So do not keep money locked up in your safe. Always invest money. Always make your money grow!

Whatever you do, do not just lock your money up in your safe and keep it stagnant. If you do this, you will be loosing money without even knowing it. The more money you keep stagnant the more money you will be loosing.
"The power of compounding!"

Compounding is a very interesting and powerful thing. It has great rewards in store for people who invest when they are young. If you invest later in life you will not be able to make use of the great “power of compounding”!

Just to give you an example…assume that there are two people. Ram and Sham.

Ram invests Rs.5000 each month for 10 years from the time he became 25.

Sham invests Rs.5000 each month for “25 years” from the time he became “35”.

Note that Ram invested Rs.5000 monthly for only 10 years. Sham invested Rs.5000 monthly for 25 years! Now, who do you think will have more money when they are 60? Think about it a little! Who do you think will have more money at age 60?

Assuming that their money grows at 15% per year, at age 60 Ram will have Rs.4.6crores!!

Sham will have Rs.1.5 crores!!

A difference of Rs.3.1 crores!! Ha!!

Think about how foolish Sham has been. When he was young and 25 years of age, he had not got married yet. His expenses were low. He had a lot of money extra each month. He would generally blow it off on parties! Later he got married. His expenses grew! He had very little money to invest. Finally at the age of 35 when he again started to have some financial control, he decided to start investing. Since his friend had stared earlier than him, he tried to make up for it but investing for 25 years. (15 years more than Ram!) However, still he ended up loosing 3.1 crore!!

Don’t be a Sham! Don’t make this mistake.

If you are wondering how this can happen, you need to understand how compounding works. Suppose you invest Rs.100 today. It grows at 15% compounded rate every year, then next year you will get Rs.115 i.e. Rs.100 + Rs.15. Why Rs.15? Rs.15 is 15% of Rs.100!

Okay so now one year is passed. You have Rs.115. The next year you will get Rs.132. Why Rs.132? Rs.115 + Rs.17. Why Rs.17 ? Because Rs.17 is 15% of Rs.115!

Now, try to use your imagination. Initially your money will grow at a slow rate. But once the money grows to a big amount the rate of growth will be very very very high! So, basically you need a lot of time to reach a very very high rate of growth. But once you reach the high growth rate then money will just start flowing! And if there is one thing the youth have, it is time!

In fact, you should invest as fast as possible. If you are not earning yet, invest your pocket money!

Just to give you an idea, if you invest Rs.1 now. You let it grow for 30 years at 15% rate, at the end of 30 years you will have Rs.67! So think of it this way. If you want a good amount of money after 30 years, invest as much money as you can invest right now. For every one rupee you invest you will have Rs.67, 30 years from now! So if you invest Rs.5000 now, you will get Rs.3,35,000 30 years from now! So what are you waiting for. Invest the money now when your expenses are low and you have the chance. You have time on your side!

I guess you probably now understand the need for investing. So, let us get right into it…
How to invest? - The basics!

Before we get into specific things that you should invest in, let us take a look at the general procedure of investing. How you should view investments, what are “risk-profiles” etc. These are the basic concepts of investing that will guide you though all your investments.


Step I: Setting Investment Objectives!

As we mentioned earlier, there are many reasons why you should invest. Some of them are “short” or “medium-term” things like the “big buys” that you want to make. Some of them are more “long-term” like “you want to retire at 45” or “you want to become a crorepati at 45” etc. Setting the objectives for an investment before making a particular investment is the first step!

Just to give you an idea, let us take an example. Suppose there is a Mr.Raju and he wants to take his wife for a trip 5 years from now. Now, Mr.Raju has a elaborate trip planned for his wife. He calculated his expenses and it has come to Rs.400,000. Raju is wise and he knows all the bad effects of taking a loan from the bank so he has decided to invest some money every month so that 5 years from now he has Rs.400,000 in hand.

This is Raju’s investment objective. This is what Raju keeps in mind while investing. So Raju finally does the required calculations and figures out that: If he invests only Rs.6,800 every month then after five years, if the money grows at 15% then he will have Rs.587,000. Raju thinks that this is perfect since he can afford to invest Rs.6800 each month.

This is how investments are done. Before you make any investment, you must first decide “why are you making that particular investment?”. Then you will know how much money you need to accumulate and in how much time. Once this is known, you can calculate backwards and you will know how much you need to invest each month to reach your aim.

Don’t just make random investments. This generally gives you the feeling that you are investing a lot but later on you will realize that it was not much since you invested in an unorganized manner! Before making any investment, decide your investment objective. This means that you have to basically decide two things:

1. How much money you want to accumulate?
2. In how much time?



Step 2: What is your “risk-profile”?

In investments there is a relationship between “risks” and “returns”. The higher the risks the higher the returns. The lower the risks the lower the returns. There are some investments you can make which will “double” your money within a very short time. However, these investments are really “dicy” or “risky”. If they do not go as planned, you may end up losing the money you invested.

For example, a friend of yours comes to you and says, “I have a great business plan! I want Rs.40,000 from you and within 6 months I will give you Rs.80,000! Please help me out…” This might work, or it might fail badly. The risk involved is high. However, the return of the investment is also quite high! A 100% rate of return in 6 months!

There are other investments that are very secure. They have very little or no risk involved in them. For example, if you invest your money in a bank that offers a 6% interest rate, then irrespective of what happens, your money will grow at the small rate of 6% each year.

So, basically, before you invest, you first need to check out what is the risk associated with the investment. Is it a risky investment? Can you end up losing all the money you invested? Or is a safe or “sure-shot” investment?

Then you need to see your situation and your “investment objectives”! Can you handle the risk of the investment? Is it crucial that the investment pays off for your objectives to be accomplished? Is the time in which your objective must completed so low that you NEED to take up a risky investment with high returns?

Think wisely about this and your situation and your objectives! If you do not, you may end up losing a lot of money! Think practically and realistically! We are not able to give you more practical information about this because everyone has a different situation and different objectives and can take up a different amounts of risk.

Generally young people can take up more risk. They have time on their side! Even if something bad happens and the risk causes them to loose some money, they can always recover it since they are young. Since young people can take more risks, they can enjoy higher returns also. One more benefit of investing when you are young!

Older people cannot take up so much risk! They do not have time on their hands. If they loose too much money, they do not have that much earning power and they may never recover from the loss.

Next, when we talk about all the possible ways in which you can invest your money, we will also talk about the risk and returns involved in each kind of investment!