Demystifying Personal Finance

Overview

Managing your own money and making it work for you is as important if not more compared to earning money.

We all need money to live a financially comfortable life but end up under considerable financial strain at different points of our lives. There are a few external factors beyond our control that would put us in this strenuous situation. But for the most part there are a few options that we can deploy and gained better prudence. This will help avoid or reduce the impact of external factors.

We all work for earning money to maintain a specific lifestyle, but we do not make the money work for us. If you are in your 30s or 40s and your “money is not working for you” or you are concerned that you would not have enough money after retirement to take you through your second phase of your life, then you need to relook at your financial habits and take corrective actions to start protecting and growing your prime asset – your finances. The best time to act on it is NOW.

The series of topics and thoughts is an attempt to help you be more aware of your finances and take better control of your money.

Let us start with a few ways to slice the savings, investments or protection based on objectives for which these are used.

Investments

Short-Term Deposits

Short term investments are often referred to as liquid investments. Few of these may not be investments at all. The key purpose for keeping such money is to ensure that money is available quickly for meeting day-to-day expenses. The secondary purpose is to have quick access to it during emergency or a financially impacting life event. Typically, short term investments can be accessed in a matter of a few days. A few examples of short-term investments are Bank Accounts, Bank Deposits.

If we do proper planning, we will have a few more that get added to this category. This will be covered later in this chapter.

Usually, the key characteristic of such instruments is that they will yield almost 0% interest so your money will not grow. There is a tradeoff between quick access and returns that is required. This brings us to an interesting question “How much short-term money we need?”

There are a few rule-of-thumb suggestions that we need to have at-least 3 months of our average monthly expenses into short term account. This may translate to about $10,000 to $15,000 in short term instruments. If you follow this book and my advice, I promise you that you can do with less than $5,000 at any given point of time and still address the key purposes of meeting your day-to-day expenses and emergency funds.

Medium-Term Investments

The next category where the bulk of our monies reside are Medium Term Investments. These are usually the money that we would like to set aside for a material event that is expected to occur in the future. Typical examples of such investments are shares, mutual funds, Exchange Traded Funds (ETF) and vested stock option plans.

We are okay to stay invested for a period varying from 1 year and over. Such investments usually are accessible in a matter of days or weeks and would provide a reasonable return based on your risk appetite. You carry a risk of losing the invested amount if the underlying security does not perform well – at such time you enter a philosophical discussion on your choice/ timing of the investment or an adverse event beyond your control or you resign to your fate.

Choosing the type of instrument that suits your investment objective and your view of the future become important. The source of such determination is usually your own analysis or advice from a trusted individual or a financial professional. This is where subjectivity comes in and what would seem to be the best decision at the time you make it would be a day you would live to repent.

There is no right or wrong when you buy equities. The whole reason why markets exist and fluctuate (sometimes more wildly than you can take it) is because for every person that would like to exit a stock or an equity, there is someone who would enter.

I will be covering the common biases and influences later during this section. I will also cover in detail how you can significantly de-risk your Medium-Term investments by adopting regular investment strategies and a few ethical hacks that will help you ride on top of the waves and get superior returns over the underlying asset that you plan to own.

What I will not cover in any section is ideas for making quick money and speculative investing. There are several websites that will help you make this determination.

Special Purpose Investments

This is a spill-off from the Medium-Term Investment Category where the invested funds can be used for a special need or requirement. Examples of products in this category are 529 Plan; where the proceeds can be used specifically for education and HSA accounts that can be used specifically for medical payments. HSA accounts can also be categorized as Short-Term Deposits as they act as bank accounts. Most of them however also have an option for the account holder to invest. The advantages that such Investment Instruments provide are usually you can invest your pre-tax money and reduce your tax incidence during the year you deposit the money. The disadvantage is that these investments are subject to market risks (depending on the asset class you choose to park your money) and moreover, they must be consumed for the purpose they are designed, or you would have to pay a penalty to withdraw the money outside of the stated purpose.

Long-Term Investments

The third category, that is also referred to as the most illiquid kind of investment, is the long-term investments. Usually such investments, if liquidated, can result in substantial cash in your hands when required but it may take several weeks, months or even years for you to cash out. There is a cost associated with availing this asset class quicker but usually you would have to settle with a loss or penalty when you cash out.

Typical assets that fall under this category are Investment Home, Retirement Plans (I am assuming you have at least 10 years left for your retirement. If you are already eligible to withdraw from retirement plans, then this book may not help you much).

Note the distinction that I have made on specifically mentioning “investment home” and not counting your own home in the calculations. This is because if you sell your own home where would you stay?

Protection

The next category that most of us either completely disregard or mis-categorize under Long Term Investment is the Protection Asset class. Life Insurance, Long Term Insurance and Health Insurance are examples of this asset class.

The reason why we cannot consider life insure as an investment is very simple. If you have “invested” in your own life, then you will not be alive to reap its benefits.

Even if you have a similar argument with health or long-term insurance, note that this still holds true as you would not be paying premiums to make money out of your or your loved one’s ill health, but you will use it to partially or totally offset your financial losses due to the medical emergency.

I have come across several individuals that do not consider protection as a separate asset class and/ or believe they do not need insurance. My younger clients know for sure that they are going to live eternally. This thought persists till they turn 50 years (or a death in their family whichever occurs first) when reality strikes. Till then it is too expensive to buy protection.

I would be recommending in subsequent sections how it would be beneficial to get good quality lasting protection at an early age as the cost of insurance is very low. There are insurance products available in the market that would outlast the oldest living person on earth which means that the death benefit is assured irrespective of the age at which insurance is purchased.

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