Category Archives: Debt Trap

Are Your Finances Under Stress?

If yes, how will you know about it before you run out of time?  Similar to economic indicators of a country that can tell if economy is doing well or not, you can draw up these four financial statements to know about your finances.

a)      Income & Expenses Statement
b)      Cash Flow Statement
c)      Family Budget
d)     Net Worth Statement

(In later write-ups I will explain each one of them in detail.  Advanced Financial Planning also employs ratio analysis techniques to monitor financial health.)

Income and Expense Statement, prepared usually for a period of one financial year or plan year, can tell you whether your income is sufficient to meet your expenses.  If you end up with surplus, it indicates that you are on the right track.

Sometimes, Income & Expense Statement can be deceiving because it does not measure the cash flow.  A cash flow statement measures the actual cash you receive and give away during the same financial year.

Just to highlight few differences between Income & Expense Statement and Cash Flow Statement, your income and expense statement may include performance bonus that you may not actually receive.  It may also include accrued interest on which tax needs to be paid. Your cash flow statement may show the amount returned by your friend who had borrowed at some immemorial time.  It may also include the mutual fund redemptions you are likely to make in the financial year.

Family Budget will tell you if you have enough rupees to spend each month of the financial year.

Net Worth Statement (or Balance Sheet) provides pointers to the long term health of your finances. It shows how much you own and how much you owe.

Some of the financial stress indicators are:

  • You have more than one credit card and each has some unpaid balances.
  • You use credit card more often than debit card.
  • You are spending all your earnings or more than your earnings.
  • You use credit card borrowings to balance your family budget.
  • You are often in the habit of borrowing from your parents and friends with reasons such as “I am running short of cash” or “I will square up in my next month’s salary”.
  • You are using ‘revolving credit facility’ or ‘convert to easy EMI facility’ in your credit cards.
  • You have more than one personal loan borrowed for purchase of things that lose value once you buy them.

Following situation may indicate that you are under severe financial stress and may need immediate attention and help:

  • You are defaulting on your minimum payments of your credit cards or EMIs, for several months in a row now.
  • Banking and Financial institutions are unwilling to lend you anymore.
  • You are borrowing at very high costs just to repay either the old loans or the minimum payments or just the interest.
  • You are stopping your on-going saving and investment plans and/or also redeeming the investments beforehand.
  • You are pledging your existing financial assets such as fixed deposits or cash value insurance policies to pay interests.
  • You have unpaid term and health insurance premiums.

Surprisingly (or unsurprisingly), financial stress has nothing to do with your personal status.  If you are a bad money manager, it can affect you even if you are responsible for millions of rupees of revenue for your employer and you head a large team of people.  It can affect you whether you are a business person or professional or salaried employee. It can affect you at any stage of your life if you have not learnt the lessons and haven’t inculcated prudent financial habits.  It can affect your household even if both spouses are drawing million rupee salaries each.

Prevention is better than cure.  If your doctor says that you must walk every day for at least 30 minutes, do not ignore the advice. It may save you from lot of troubles in future. Similarly, if you are under financial stress, mildly or especially severely, do not hesitate to talk to your elders and/or professional advisers and listen carefully to what they have to say.  You should also speak to your spouse openly and honestly because he or she has to stand by you in the difficult times.  You can also talk to your tweens truthfully and involve them in the recovery plan. Talk to your friends only if they are dependable.  It may not help you much if they have also played a role in the first instance or if they are in bad shape themselves.

It may surprise you, but just the same, the old adage of stretching your legs to the length of your bed is the advice you will receive from all your well-wishers including your financial planner.

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A ‘Sinking Fund’ for you

Congratulations for the purchase of a spanking new model diesel car that has set you back by few lakh rupees.  I know that you like to take long rides and at the same time reduce the cost of fuel so diesel car is an ideal choice. While you are enjoying the drives, please bear in mind that today’s new car gets older by the day.  A time will come, several years down the line you may have to replace today’s love (car I mean) with a better one.  What are your plans for that?

A business or a company, when it buys a machinery, also sets up a fund what is known as ‘sinking fund’ to buy a new one when the existing one reaches end of its productive life.  Business owner/manager doesn’t have to worry about funding the replacement.  Sinking fund just steps in to fund the new purchase.

What a business does in setting up and using a sinking fund can also be easily adopted by you.  Pre-requisite however is compartmentalising your saving/investments.

Let us suppose you want to replace your existing car with a new one 5 years down the line and you expect that you can buy a car then at Rs.10 Lakhs.  So how much money you must set aside each period?  Using Excel Function PMT() you can easily find the answer.  If you expect that you can earn 8.5% return per annum (that is 0.71% per month), you need to set aside a sum of Rs.13,433/- each month.  If you play with PMT() function, you will also realise that as your expected rate of return increases, monthly saving decreases.  This analysis also provides you an insight as to which asset (debt or equity or combination of both) you must invest in to reach your goal.  Businesses traditionally use safer assets such as debt.  If you decide to use equity as well, please take care to rebalance to a safer asset well before the target date.  Otherwise, there is the danger of your investment losing value due to volatility when you most need it.  If you have noticed, you need to save less than Rs.10 Lakhs because your saving/investment earns returns which could be substantial depending on the timeframe and choice of assets.

You can adopt this method to fund any large and infrequent expense or purchase.  If you talk to your financial planner, she will also tell you how to adjust the investment to take care of taxation and inflation.

There is a deeper message for you in this arrangement:

Firstly, you have to postpone your urge to make that large purchase to tomorrow and set up a saving or investment plan.

Secondly, you should compartmentalise each saving or investment plans, tag them to the respectively goals and should not dip in to them for un-intended needs/uses.

Thirdly, you should choose the right investment option/vehicle that suits your requirements and money-personality

These are not easier things to achieve unless you are focussed on the purpose and before attempting this technique, you should have become your own banker.

Do You Have A Spending Policy?

Your life is bound by innumerable policies. Starting with insurance policies, you come across policies for everything in your life:

There is parking policy, ATM withdrawal policy, Lost Card policy, HR Policy, Travel Policy, Reimbursement Policy, BCRP, Staff Purchase Policy, ESOP, ESPP… Except your spending policy.

What is your spending policy? Is it ‘need based’ or ‘emotion based’? Do you just buy now and think of how to pay later? Do you spend only when you receive your bonuses? Do you embed your spending requirements in your family budget? Or do you simply have a policy of ‘having no policy’? Please remember, when I say ‘spending’ here it means spending on ‘discretionary’ things and not ‘necessities’.

It is important that you have a spending policy. I just went through today’s newspaper and found these sales and marketing enticements:

  • 24 Hours delivery challenge, get 3% cash back (if we fail to honour our commitment)
  • Free Installation, Free Stabiliser, Free Delivery (all worth Rs.5000/)
  • Free assured gift (up to Rs.4999/-)
  • Hurry! Stocks are limited
  • Credit Card EMI Shop and earn 5 times payback points
  • The great exchange offer
  • Get up to 40% off
  • Last 3 days to redeem your exchange coupon and get up to 25% extra discount
  • Lifetime warranty of 15 years
  • Easy Finance Options
  • Special offer on 3/6/9 EMIs
  • Easy Finance on Credit Cards
  • Same day delivery
  • 80% off on international prices
  • Nil Margin Sales
  • Pay Rs.599/- only and take home any electronics product at 0% interest
  • Free Gift coupons worth Rs.3000/- 0% interest in 8 easy EMIs

I have eliminated some of the common enticements of type ‘buy 1 and take 3’.

Best of the talents are working overtime to come up with newer and better ‘enticements’ and ‘traps’ to induce you to spend more and more. In fact, currently India’s growth is sustained by spending or consumption. Spending is good for the economy. It is also good for you if you are an investor. If you anticipate that spend on health care are likely to increase, don’t rush to buy health insurance. You buy shares of companies in health care industry. This can be replicated in other sectors of the economy.

Coming back to the subject of spending policy, we professionals more or less agree that ‘cash-only’ spending policy is the best one for you. You buy things you desire only when you have your own cash.

By the way, what is your most liked sales offer? I liked “Lifetime warranty for 15 years” just for the built-in contradiction.

Can You Be Your Own Banker?

How difficult or how easy it is for you to put a strong foundation to your financial future?  If you ask me, it is fairly simple and easy – and hence mostly ignored.  Can you become your own banker?  Yes, it is possible.  Let us analyse the reason why you wish to avail easy credits such as credit card borrowings and personal loans.  Mostly, it is to buy items such as a bike or a car or white goods.  You are aware that such loans are easy to obtain and difficult to service.  If you become your own banker, you can borrow from yourself (not difficult paper work!) and pay back at your own pace. Here are the steps through which you can set up your own mini bank:

a)      Start contributing small instalments in to an account, which you can achieve easily, say starting an SIP in a debt fund.

b)      If you contribute let us say Rs.5,000/- each month, in a year you will have Rs.60,000/- in the account and in 3 years Rs.180,000/- plus the growth.

c)      When you need to buy any of the things I mentioned above, borrow from your own bank (debt mutual fund portfolio) and repay with interest (continue the SIP).

If it is such a simple thing to do, why many don’t do it?  The answer lies in the simple economic behaviour which says that “you consider today’s needs more important than tomorrow’s needs”.  To fulfil such needs, you have to borrow if you do not have the necessary money today.  Saving today for tomorrow’s needs requires great sacrifice by you but it is worth doing.  If you develop this habit, you can easily run your own mini bank, you being the sole customer and this habit would become a very strong foundation for your financial future.

Pay For Yourself Instead Of Paying To Credit Card Company!

One day, I received a call on my cell phone (unsolicited) and a sweet talking voice announced that it’s a call from Xyz Bank and that I am the lucky one selected from their database being eligible to receive a free life time credit card with a credit limit of 1 Lakh Rupees. Sweet talking voice also informed that I will be eligible to receive free accident insurance, club membership benefits, discount coupons, festival offers, cash back facility, blah blah blah.  Sweet talking voice asked for the confirmation when to send Bank’s executive to complete the paper work.    

I fixed up a time for that and started dreaming as to what are things I can do when I receive my credit card 

Ø       I can buy latest clothes, sports shoes, mobile phone etc.

Ø       I can also buy latest model of IPod, Digial camera, DVD player

Ø       I can go on a trip to Goa..Kumarakom..

Ø       I can take all my friends to that chic pub for my birthday party

The list continued to grow longer and longer till I fell asleep. 

Next day when I was about to start-off to office when I received a call from another sweet talking voice.  This time the voice announced that she has come know about my intention to apply for a credit card and a Certified Financial Planner would like to talk to me about an alternative plan.  She also informed that she will send a vehicle to pick me up from my workplace during the lunch break to meet up with CFP and discuss the alternate plan over lunch and that I will be dropped back to my office in time. I agreed for this meeting with CFP thanking my luck. 

I was promptly picked up that day afternoon and driven to a posh hotel. There was waiting for me at the lunch table a gentleman in a blue suit with a laptop kept ready on the table.  As soon as I sat down after thanking him for the kind offer, with a waive of hand he called a waiter and ordered for the lunch.  The next moment he started off with his presentation about an alternative plan to credit card – a  “Pay for myself” scheme. 

Without wasting much of your time, I give here the gist of the alternative proposal.  I still do not know how this CFP had all my personal information but here they are 

Credit limit available in Xyz Bank’s credit card – Rs.1 Lakh 

Amount I intend to use in the next 15 days through credit card – Rs.1 Lakh 

My monthly surplus after accounting all my expenses – Rs.6000/- 

Minimum amount I need to pay my credit card – Rs.5000/- 

When I will be fully repaying the credit card loan at this rate – nearly in 31 months 

Total Interest I would pay the credit card company – Rs.55,000/- Rate of interest – 36% Per annum

 The strange alternate plan CFP proposed was some what like this. 

Postpone my purchases till such time I have enough cash in my bank account (in any case you can live without them!) 

Save an amount of Rs.5000/- every month through an SIP in a mutual fund 

At an expected annual return of 12%, in roughly about 18 months I should have a sum of Rs.1 Lakh in my mutual fund account 

Spend the money as I like from the mutual fund account with the condition that I will repay the amount to my SIP account every month 

I may be eligible to get some cash discounts on my purchases

I suddenly stopped eating my lunch.  My blood boiling with cold rage, I started yelling at the CFP about his stupid idea of saving first and then spending my own money.  Why should I do it when I have the option to use Xyz Bank’s money and the easy option of paying in installments.  After paying part of the amount, I can use the balance credit limit again (my list was not fully exhausted when I spend lakh of rupee using my card) and I can keep paying the minimum amount to the credit card.  It’s cool using the plastic money!

The CFP interrupted in the middle and informed with a smile on his face that I will continue to work for the sake of credit card company and not for myself and If I continue to use my credit card in such a manner, all my surplus income will have to be given to the bank.  I really got wild with his utterance.  I picked up a glass of water on the table and threw the contents at CFP.  With annoyance I noticed the CFP suddenly vanished in to thin air and somehow all the water turned and fell on my face. 

I woke up suddenly from the sleep to realise that all this call from CFP and luncheon meeting was just a dream. I started off to my work with the happy feeling that I will be meeting the executive from Xyz bank to apply for a life time free credit card. 

If any of you meet any CFP any time, be forewarned.  They will ask you save your own money first and then spend.  They will also ask you to pay for yourself instead of paying to credit card company.