7 Delusions on Managing Personal Finance Busted
Many individuals have an erroneous perception about reality. They believe, the practice they follow in whatever they do, is right. But the fact is that they are under delusions and not in terms with reality.
A primary reason for this is that they feed on incorrect information and views. A vital point to note is that while you take an advice, it is imperative to see who you take it from. Going by views from folks - be it family and / or friends may not be prudent. Likewise, in the jet age of information technology, while information on anything is available at our finger tips, you ought to recognise and distinguish between 'information', 'knowledge' and 'wisdom'.
Remember, wisdom is at the pinnacle...and thus only words of wisdom can guide you well to take well-informed decisions.
Nevertheless, many get swayed by what comes their way and land up following imprudent practices. Through experience we can say that delusions or erroneous perceptions are so rooted even while managing personal finance and investing, that people keep making grave mistakes.
Here are some delusions or misapprehensions many individuals live by...
Delusion 1: Investing should be exciting
Tips from brokers, agents, distributors, friends, family...and even unsolicited advice by business news channels has made investing appear more exciting. Investors are often looking for thrill, especially in equity investing; but fail to recognise that thrill can jeopardise the long term financial well-being and be even hazardous to health.
The reality and approach: Remember, good investing is essentially dull and boring. There is no point getting swayed by exuberance. It is imperative to recognise your risk profile, investment objectives, investment horizon, and financial goals amongst host of other aspects before flocking on to investment products. Also you should be serious investor and not a trader, because a trader is only good until his last trade.
Delusion 2: I don't need to diversify my portfolio much
The pink papers as well as business channels often paint some picture or another on various sectors - be it infrastructure, bank, auto, oil & gas, FMCG, Pharma, etc. Various sector analysts along with some industry professionals too, do provide their views thus making the story look more appealing. This has influenced many investors to specific sectors. Some even concentrate their portfolio to a specific market cap segment - large cap, mid cap, small cap and microcap - without having much recognition of traits of each segment.
Likewise harping on the fact that equity is one of the best wealth creating asset class, has got many incline towards equity without recognising what suits them the best. Similarly, there are those who actually should invest in equity to plan their long term financial goals, but have kept away from them and opted to invest in debt instruments.
The reality and approach: Diversification has been widely talked about for the merits it offers. Hence it is said...diversify, diversify, and diversify!!
But often it is either ignored or incorrectly or incompletely followed by many investors. It is noteworthy that diversification is one of the basic principle of investment planning. It helps one in reducing the risk to one's portfolio, and thus makes it resilient. But having said that, you need to diversify in a prudent manner which can aid you a cushion against the wild swings of the markets. There are many ways you can diversity your portfolio smartly such as:
- Diversification across asset classes
- Diversification across investment avenues
- Diversification across time horizons
- Diversification across issuer of securities
Delusion 3: I have invested in tax saving instruments, so I'm done with my tax planning
The focus on most individuals when it comes to saving taxes, is investing in eligible instruments eligible for deduction under Section 80C of the Income Tax Act, 1961 and claiming for deduction for insurance premium paid under Section 80D of the said Act.
The reality and approach:Investments in tax saving instruments are done in the last couple of months of the financial year, as individuals start feeling the heat to save tax. Well, this approach does not ensure holistic tax planning. There's more to tax planning than merely investing in tax saving investment instruments. Tax planning involves taking cognisance of one's larger financial plan after accounting for one's age, financial goals, ability to take risk and investment horizon (including nearness to financial goals). And by adapting to such a method of "tax planning" you not only ensure long-term wealth creation, but also protection of capital.
Remember there is more to tax planning than Section 80C and Section 80D. There are numerous deduction under chapter VIA of the Income Tax Act as well as exemptions, which you should take utilise optimally in the tax planning exercise.
A home loan can help in tax planning, as you can avail a deduction for interest paid (under Section 24(b)) and principal amount (under Section 80C). If you are a salaried individual, you should restructure your salary wisely in consultation with your employer. You should ask for more allowances and reimbursements, which can help reduce your tax outgo.
Delusion 4: ULIPs, Endowment and money back plans can take care of my insurance needs
In the pursuit of killing three birds, namely insurance, investments and tax savings in one shot, many keep buying insurance policies and perceive that to be a wise thing to do and are optimally insured. This perception has built because, like thieves, insurance agents have fleeced investors with their hard earned money by mis-selling products.
The reality and approach: ULIPS, endowment and money back plans are expensive propositions for insurance needs. By charging a high premium, the insurance cover which they offer is far sub-optimal. Moreover the investments in these plans yield an insignificant real rate of return, thereby not meeting the investment objective meaningfully. Hence investment and insurance needs should be dealt separately. When you are looking at insurance, your primary objective should be indemnifying risk to life and you should do so optimally by assessing your human life. To take an insurance cover term plans are the most appropriate, as for a lower premium they offer the maximum risk cover.
Delusion 5: I don't need to plan my retirement. I have enough money and time!
Many often dream of a blissful retired life, but fail to plan to make it indeed blissful. Those who have lots of pots of money, display arrogance and disregard that inflation bug would eat into the purchasing power of money. Some who are not so wealthy but have time in hand, procrastinate planning for retirement. They get lured by immediate gratification and in the bargain end up struggling to manage their retirement needs later. Hence a dream retirement becomes a reality for only a few.
The reality and approach: Although you may be well-to-do, the future is uncertain. You may have noticed things that cost of living has gone up quite a bit over the years and the value of money has reduced. This is because the inflation bug eats into the value of money. Also, God forbid if you go through financial crisis it could impact your idea of blissful retirement.
Procrastinating to plan for retirement is the biggest enemy. In fact, starting early and ensuring that you have sufficient time on your side is the key to a blissful retired life. Being young provides you a benefit that is not available to all, 'time' (which can enable better compounding of wealth if invested wisely). As it is said, "the early bird gets a bigger pie".
You must understand that retirement planning is the only key to remain financially secured and maintain a comfortable standard of living even in the later years of life, where you may not draw regular flow of income. You see, planning for retirement can keep you financially independent even during your golden years, taking care of day-to-day expenses, medical emergencies (that may arise as age progresses) and even enjoy a decent lifestyle during retirement.
Delusion 6: I don't need a financial planner, I can do it myself
If you are living under this misapprehension and want to go your way in planning your finances it can sabotage your long term financial wellbeing. Many think that they don't need a financial plan, as they come from an affluent class. Many from the field of finance believe that they can be their own financial planner, but financial planning is different ball game.
The reality and approach: If you don't realise where and how your income is spent every month, do not save and investment regularly, know what your liabilities are, investments are scattered, not sure if investments are made wisely, don't know how much should be your insurance cover and which insurance policies to keep, want to plan for your financial goals but don't know how you allocate your assets... you need the services of financial planner who can build a financial plan truly in an unbiased and independent way irrespective of the economic strata you come from.
Those from the field of finance need should recognise that financial planning is a specialised arena which involves:
- Assessment of your Risk Appetite
- Assessment of your Contingency Requirement
- Assessment of your Life Insurance Requirement
- Restructuring of your Existing Loans
- Review of existing Mutual Funds
- Review of existing Life and Non-Life Insurance Policies
- Analysis of Future Cash Flow
- Planning for financial goals such as House Purchase, Child Education, Child Marriage, Vacation, Retirement etc.
- Defining asset allocation
- Rebalancing of Portfolio
- Recommendation on New Insurance Policies and investment recommendation
- Action Plan
A financial planner is someone who will draw a financial plan that will help you to define and prioritise your goals, analyse where you stand currently with respect to your financial situation and provide you a clear road map of how to achieve your financial goals. Such an approach ensures that you are well equipped to deal with dynamically changing circumstances such as inflation and lifestyle. You see, in the absence of a financial plan, you might not be empowered to accomplish what you have dreamt of achieving and might also be under-prepared to deal with unforeseen contingencies. But enough care should be taken while hiring the services of financial planner.
Delusion 7: I don't need to involve my family while taking financial decision
This is one misapprehension we have heard while advise clients on financial planning. It is observed that many individuals take views from family members onto what to shop, where to dine, next holiday destination, etc., but don't involve their family while taking important financial decisions and even if they do involve, they do not discuss in much depth. Discussing financial affairs and decisions with family members are often regarded as unimportant and unnecessary. Children's involvement in vital financial matters is kept minimal as it perceived that they are too young to understand things.
The reality and approach: It is extremely important that you involve your family while taking vital financial decisions which can have an impact on your long term financial wellbeing. You should be open to discuss financial matter with our spouse, because as life partner you may have envisaged financials goals which you want to fulfil - which could be buying a dream home, a car, children's education, their marriage, your retirement amongst host of other things. The way your spouse would like to realise these financial goals might be different. His / her opinions about various subjects can bring a great deal of clarity and another perception to your financial plan.
Likewise many of you would agree that today's generation is very smart and are fast learners due to their inquisitive acumen. Schools today are also training children about personal finances. But having said that it is imperative to involve your children while taking financial decisions for the family, especially the ones that will affect them, and infuse in them the value of money no matter what your economic status is. Today, while most parents want to provide their children with the best education of all, it is imperative to involve the child while creating a financial plan for the said goal. You see, children learn a great deal by observing. Discussions like these will create curiosity in their mind and help them understand the family's financial situation. As parents, the earlier you create financial awareness among your children, the lesser mistakes they would make as they grow up.
"All men make mistakes, but only wise men learn from their mistakes."- Sir Winston Churchill.
The above proverb is very much relevant to our daily lives - be it handling finances or even in any other facets of life.
John C. Maxwell has also said, "A man must be big enough to admit his mistakes, smart enough to profit from them, and strong enough to correct them."
So in the backdrop of these words of wisdom, rise-up and move away from these delusions to lead a healthy financial life.
PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.
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