We have heard a lot about IQ and the more recently popular EQ [Emotional Quotient], but what about financial quotient? IQ and EQ are intertwined in our genes to a certain extent and can be improved with practice and training. In urban areas, peer pressure, external influence, the “to be with the Joneses” aspiration and consumerism have pushed back the importance of financial discipline. The article is specific for Indian investors though most of the ideas expressed are universal
Those who were born in India in the early seventies to mid eighties can be said to be in a cusp where they were brought up seeing the high financial quotient of their parents as the pre liberalization era had a certain leash on earnings and affordability. There was a high propensity to save. Cut to the present – every time we visit Big Bazaar or the neighborhood toy shop we give in to our kids’ intransigent demands. We indulge ourselves with expensive gadgets. This way of life was unheard of when we were kids.
Chocolates and toys were to be earned and not considered a right. We find it difficult to ‘Kinect’ [pun intended] with the aspirations of the present generation kids. For them chocolates and toys have now been replaced by I-pads and PS3s.
The post liberalization growth push and the tech revolution changed everything. It gave us a sense of affordability and an increased exposure to consumerism. The present “have money; will spend” attitude leads to financial drain if practised without financial discipline. It is akin to a tap dripping water and draining your overhead tank. Financial discipline is extremely important if you want to build wealth.
Two points to remember before we move ahead
a. Wealth is created to enjoy its fruits. Take good care of the tree so that the flowers are allowed to bloom and give you fruits. Do not pluck them early.
b. You are what your personality makes you. A drastic change can make you unhappy, so make the transition slowly but surely to create and enjoy your wealth. Spend in moderation and invest wisely.
Financial discipline is not about setting goals, writing it down and systematically working towards it. Those concepts are what you will find in any management book. I would suggest that you be aware of the impediments that come in the way of practising financial discipline. Avoid falling into those traps that eat away your earnings. If you get a grip on these then you are on your way to creating and protecting your wealth.
I am sure all of us have done this not once but many times. Most of the time you will end up regretting the purchase or it will be thrown out/given to the house maid a year later when you suddenly get the urge to purge your house of all things unwanted. Advertisers and point of sale promotions use the emotional bait and repetition to ensure you are primed for an impulse purchase. The seller uses every kind of lure from, buy-one-get-one-free to freebies and what not. Knowledge is power. So be aware of this common fallacy that makes us human. Instead make use of stock clearance sales after the festive season and turn the tables on the seller.
Most high street brands sell solely on this. Who would not want to jet set in a high end Merc with a diamond studded watch on one’s wrist and a Mont Blanc pen in one’s pocket? ‘Mere pass ma hai’ is no longer considered hip. Advertisers love it and use it to influence decision making, and companies take full advantage of this to make more profit. It is essential that you are aware of this and maybe ask some questions to yourself before you succumb to your ego. Is the purchase solely to satisfy my ego? Do I have the capacity to buy this? This is not just for the high end stuff but even applicable to your perfume or brand of clothes or mobile phone. Finally the choice is yours. A high end purchase may give you short term gratification but remember for the majority of us it just does an ‘axe effect’ on our wallets.
Excessive reliance on one type of saving
Ignorance, wrong perception or risk aversion can cause an individual to tank up on just one type of investment. If you have a treasure trove of insurance products or FDs or if you have invested only in the stock market, then you are not maximising your returns. It is a good idea to diversify your portfolio. A good strategy would be to give a 15-25% exposure to stock markets. Stock market exposure should be increased when there is a drastic fall in the markets. Book profits when you see extreme optimism in the stock market and all and sundry start advising investment in stocks. Move the profits to high yielding fixed income products or fixed maturity plans of mutual funds. If you prefer real estate go for land rather than apartments.
Excessive reliance on Loans/ Credit Cards
Interest is an expense borne by you. Always look at the total cost of purchase. If you have money in the bank it is better to use it rather than take that tempting low EMI dangled before you. The same goes for buying a car as well. Take out a loan only if absolutely necessary. If you buy a car for Rs. 4 lakh on a five year loan you will end up paying about Rs. 5.23 lakh + processing charges [EMI 8727]. If you had bought the car from your savings and invested the EMI in a recurring deposit that earned 8.25 % you are richer by Rs. 6.50 lakh! (The Rs. 4 lakh FD you closed would have become Rs. 5.87 lakh @8%).
Credit Card rotation and advances against credit cards come at the highest end of financial indiscipline. The ultimate chakravyuham (an ancient Indian military formation of concentric circles to encircle enemy from which escape is virtually impossible). If any reader is doing it then it is advisable to immediately close the loan to save yourself from financial ruin. For the more disciplined it is better to link payment to your salary account to avoid paying interest and penalty for our forgetfulness. Do not exceed the limit and pay dues on time. The interest rate is always mentioned per month and usually ranges from 32~40% yearly.
Some elements of financial discipline are given below:
1. Insurance: This is a double edged sword. For Life Insurance please go for term plans only. Buying complex life insurance products is sure to improve the wealth of the insurance company. ALWAYS have a valid health insurance with a cover of at least Rs. 3 lakh.
2. It would be a good idea to write down your expenses [if married your spouse’s as well. You will be surprised to find the amount of wasteful expenditure that pops up. This will also bring in an amount of control on your spending. Instead of wondering where the money is going you will have an idea of what to cut. This exercise will need a lot of patience and a will to continue day after day. But the return will outweigh the investment of time.
3. Investing wisely: Have a good mix of instruments for saving. Do not chase any asset just because everybody is buying it. In the case of real estate, stocks or gold, do not panic and buy assuming that it will go out of reach. All investment options have a cycle and there will be ups and downs. Be patient and watchful. Compare, question and think twice before you go ahead. A promise of a return greater than 12~13 % is rarely possible unless something suspicious is involved somewhere. It is better to opt for mutual funds or stock markets for that kind of return.
4. Complex Investments: In the past few years, trading in futures and options, currencies and commodities has gained popularity. The lure of big bucks may tempt you but remember they are complex and involve a lot of risk. If you cannot understand it, do not invest in it.
The above ideas are meant for the majority who aspire to create wealth and I hope that it will also add value for those who are already wealthy. This is not an exhaustive list, and comments that could add more perspective on the best way to practise financial discipline, will be appreciated.