I wrote this answer in response to a question on Quora, and thought of sharing it with a wider audience here.
When one starts earning, the most critical question he/she faces is how to manage the personal finance smartly. I faced similar question 5 years ago when I started working. I took some wise decisions, made some mistakes on the way, and finally here I am, sharing my personal experience with you in the form of these tips to manage your personal finance smartly.
1) First Save, Then Spend.
A lot of people approach saving as:
However, the correct way to approach it is
There are a few necessary recurring expenditure that you will have to take care of, such as:
- Room Rent, Electricity, Maintenance etc
- Internet Bill
- Phone bill (keep it to minimum)
Every month when you get your salary, take out the portion required for these necessary expenditures. Save a part of whatever is left and only then spend the remaining amount.
Instead of saving a random amount every month, decide on a percentage/fixed amount of what you will be saving, so that you are disciplined.
2) Buy Life Insurance
Buy a life insurance policy for yourself.
While there are a lot of insurance policies that give a return at the end of maturity, DO NOT go for that. Only buy Term Insurance plans. Though Term Insurance plan won’t give you anything at the end of maturity, you must understand that insurance is not an investment product. Insurance is bought to provide financial security to your family should something happen to you.
Why should you go only for Term Insurance plan?
Premium for Term Insurance plan is much lesser than for plans that promise a maturity amount. You can get a better return by investing that difference in some good investment plans.
Note that if you buy insurance at an early age, your yearly premium will be very less.
Another advantage: you can claim tax benefits on the premium that you paid.
3) Buy Medical Insurance
A lot of companies these days provide a family floater health cover to employees, so people don’t see a need of buying a separate medical insurance. But take my advise and buy one for yourself and your family even if your family is covered by your company’s medical policy.
Three reasons for that:
- If you were to leave your job and join a company that doesn’t provide medical cover, you will be at a risk of paying everything from your pocket should something unfortunate happens.
- It is cheaper & easier to get a medical insurance when you are young. Also, at a later stage in life if you get diagnosed with some ailment, you would have already passed the waiting period criteria that most medical insurance policies comes with and so your claim will not get rejected.
- After your retirement, you wouldn’t have to rely on your children to take care of your medical emergencies.
Additional benefit: you can claim tax benefits on the premium that you paid.
4) Maintain a Contingency Fund
Have at least 3 months to 6 months of your monthly salary in a savings account. God forbidding if you lose your job, or decide to leave it for some reason, you can survive for those 3-6 months maintaining the same lifestyle while looking for a new job.
Don’t touch this bank account. Use it only in case of dire emergencies.
5) Don’t Take Loans for Depreciating Assets
As far as possible, avoid taking loans for depreciating assets. Depreciating assets are the assets that lose their value over time, like car, bike, tv, fridge etc. Instead, if you have to take a loan, take it for appreciating assets like land/house.
6) Start a Recurring Deposit to Buy Expensive Items
So, if you should not take loans for depreciating assets, how should you buy them?
Simple, to buy any expensive item like a car, bike, smartphone etc, instead of burning your saving all at once, plan ahead and open a recurring deposit.
Let’s say that you want to buy a phone which costs Rs 30K. Rather than spending 30K at once, set a timeline to buy the phone and start saving every month towards it using RD (let’s say Rs 2.5K per month for a period of 12 months). This will have four advantages:
- By waiting for a few months, you’ll realize if you really want that phone or was it a whimsical decision
- You will inculcate a habit of saving and planning your expenses
- Your pocket won’t feel the burden all at once.
- You will earn extra interest from RD
This is what I personally do:
I open RDs for yearly recurring expenses, like medical insurance premium (which costs me more than Rs 25K yearly), web hosting space for my websites (Rs 8K yearly) etc. So when the time comes for payment, I don’t suddenly feel the load.
For other expenses like bike, phone etc, I decide a timeline for myself and use ICICI’s iWish product to save money for it. iWish is similar to a recurring deposit in terms of rate of interest, but with the benefit that it is flexible- which means that you don’t have to deposit a fixed amount every month.
Whatever extra money I am left with at the end of the month, I transfer that to my iWish account. Using this approach, I have been able to buy expensive items without burning a hole in my pocket.
7) Use Credit Card wisely
It’s ok to have a credit card as long as you use it wisely. Do not fall in the debt trap. Spend only what you can later pay. And always pay the full amount on time.
When you default on your credit card payment, your credit score, which is maintained by CIBIL, goes down. Banks can refuse you loans if you have a poor credit score.
8) Invest Sensibly
Saving Bank account is the dumbest way of investing money. You earn 4-6% of interest on it, while inflation is higher than that. So, the value of your money goes down with time when you put all your earnings in saving bank account.
Instead, invest in mutual funds & stocks to beat inflation. If you are new to the stock market, do not rely on so-called hot tips. Do your research before investing. Or, take the monthly SIP route.
Having said that, do keep some amount in your saving bank account also, so that you can use it at a short notice.
9) Invest in PPF
If you don’t want to take the risk by investing in Stock Market, save for your retirement using Public Provident Fund. It pays interest at 8.7% p.a. and is non-taxable.
Though most companies have EPF plan (Employee Provident Fund), you can still invest in PPF to increase your retirement fund.
Note that your investment in PPF is locked for 15 years, though you can take a loan against your PPF after 5 years.
10) Keep a Track of How Your Money is Growing.
Nothing will motivate you to earn more & save more than seeing your net worth increase.
I use this spreadsheet to track my net worth (read about this idea on some blog, which I can’t remember at the moment). You can use something similar if you find it useful.
Download the spreadsheet here:
Hope you found the article useful. If you are on Quora, you can read the original answer here (and upvote if you find it useful ;)).
Do you have some tips for personal finance management? Share it with others using the comment section.