Introduction
Financial literacy assumes much significance in today’s world. Financial literacy, as a life skill, is to be imparted to every individual for management of their personal finances. People face various issues like complexity of financial products, prevalence of fraudulent and Ponzi schemes, need for funds to get a better quality of life after retirement etc. These issues have generated need for a better management of personal finances with proper management of income and expenditure.
Financial education helps people in being financially literate and develop a positive attitude towards managing their income, expenditure, assets and liabilities properly, which would lead to better financial well- being.
Financial planning is a must for every household. Financial planning goes beyond savings. It is an investment with a purpose. It is a plan to save and spend future income and should be carefully budgeted.
This literature provides a fair understanding of the personal finance world explaining the concept of financial planning, key concepts in financial literacy, various investment options, savings and investment products, insurance and pension, retirement planning, caution against Ponzi schemes, tax savings options, investor protection etc.
This booklet is meant for the general investors and at the end of completion of this module, it is expected that the target participants will get better understanding and better management of their personal finances so as to achieve financial well-being.
Key concepts in personal finance
Some important concepts in personal finance which an individual should be aware of while managing the personal finance.
1. What are Savings:
Savings are the surplus of income over expenditure.
a. Income — Money earn from various sources like Salary, Wages etc.
b. Expenditure — Money spent on various items which includes essential and non-essential items.
Savings = Income - Expenditure
Money in savings account of a bank earn a small amount of interest and it's easy to withdraw it whenever needed. People can save in savings bank accounts and Post Office savings accounts etc.
People usually meet their short term goals or urgent requirements with savings. Savings is a portion of person's income which is not used for expenses. It has low or negligible risk & high liquidity.
2.What are Investments:
Investment is the act of deployment of money out of savings into financial or non-financial products with the expectation of earning higher returns over a period of time. For e.g. financial products viz. fixed deposit in bank, buying shares in stock market, investing in Mutual funds etc. and non-financial products viz. purchase of land, gold, silver etc. The period for investments can be for short, medium or long-term. It is normal for returns on investments to rise or fall over time.
Investments are made to make the money grow by creating assets that can generate income in the future. It may have low or high risk. Investments are comparatively less liquid.
3. Importance of savings and investing:
Investing actually makes money grow for you. Any interest, enhancement of value of the investment over time, or investment returns that you receive, gets you that much closer to your financial goals. One should start saving and investing early in his or her life. The earlier you start, the better you will be placed in meeting your goals like owning a house, financing your child's education, or funding for your retirement.
4.What are Assets and Liabilities:
The items that you own and can generate future income are your assets and the things which you owe to
others are your liabilities. For example, if you save and then invest in a fixed deposit, it is your asset. On the other hand, if you have an outstanding loan, say to a bank or any individual, it is your liability.
5.What is Debt:
Money borrowed for covering the shortage of money when expenses are more than the income.
6.Time Value of Money:
As time passes you will realize that if 10 years back you could afford to purchase a full lunch for 10, today you could afford to get only a few pieces of vegetables. This means that the value of a five hundred rupee note would be higher today than after five years. Although the note is the same, you can do much more with the money if you have it now because over time you can make the money grow by earning interest on the money. By receiving 500 Rs today, you can increase the future amount of your money by investing and gaining interest or capital appreciation over a period of time.
At the most basic level, the time value of money demonstrates that time literally is money — the value of the money you have now is not the same as it will be in the future and vice versa.
Delay in Investing can be Costly (example) :
Amount required: 15,00,000/-
Expected Return: 8% p.a. Duration 20 Years
Goal: Children Education
If you start investing now, you will invest 2546 Rs per month. If you start investing 3 year later, you will invest 3747 Rs per month. As much you delay, you need to increase the investment amount. Hence starting investment right from today is best deal.
7. What is Inflation and its effects on Investments:
Inflation basically refers to rise in prices of goods and services. Over time, as the cost of goods and services increases, the ability of a unit of money, say one rupee or 100 Rs, to buy goods and services keeps declining. In other words, the ‘Purchasing Power' of money decreases. It is important to take into account the effects of inflation on your investments during financial planning. Investors greatly fear inflation since it reduces the value of their investment.
How does inflation affect my investment decision?
A Pani-Puri plate costing 12 Rs five years ago now costs 20 Rs. The increase in the price is not as a result of higher quantity or a better quality but due to inflation impacting the prices of the ingredients.
What are the steps that an investor can take to avoid the adverse effects of inflation?
Try to determine your “real rate of return? or the return you can expect after factoring in the effects of inflation. To mitigate the decrease in the time value of money, you can invest the money available to you today at a rate equal or higher than the rate of inflation.
8.What is Power of Compounding:
With simple interest, you earn interest only on the principal (that is, the amount you initially invested); while with compounding, you earn interest on the principal as well as on the interest on the interest previously earned on the principal amount.
Let us understand the magic of compounding with the help of an example :
The example above shows how an initial investment of 1,000 Rs grows to 31,409 Rs over a period of time. When the return is reinvested, you earn a return on the return and a return on that return and so on.
9.The Rule of 72:
Mathematicians say that you can find out how long it will take you to double your money simply by dividing 72 by the interest rate. So let's say your parents give you 200 Rs for your birthday and you plan to invest it. If you put the money into an account that earns 6 percent interest a year, how long will it take to grow to 400?
72 / 6% interest = 12 years
So in 12 years, your money will have doubled to 7400
10. Rupee Cost Averaging :
Rupee cost averaging is an approach in which you invest a fixed amount of money at regular intervals. Say for example, you buy more mutual fund units when unit prices are low and less when they are high. By investing according to a schedule, you avoid the complex or even impossible duty of trying to figure out the exact best time to invest. The rupee cost averaging effect averages out the costs of your units and hence lessens the impact of short-term market fluctuations on your investments. For example, take a look at this table below:
(Insert Table Here)
From the above, it can be see that on a total investment of 24,000 Rs over a period of twelve months, an
investor received 466 units of Mutual fund. The average price per unit comes to 51.50 Rs
Chapter 3- Financial Planning
A. Financial Planning
Financial planning is the process of estimating financial needs of a person and to implement a comprehensive plan to meet those financial needs during his or her lifetime. For instance birth of a child, education, purchasing house, marriage or to meet emergency situations like an illness and meet the impact of an accident, death, or natural calamities like flood.
B. Financial Planning Process:
1. Determine current financial position
2. Identify & set your financial goals
3. Identify suitable investment avenues
4. Evaluate alternatives & strategize
5. Create & implement your financial action plan
6. Review & revise the financial plan
Determine Your Current Financial Situation
If you want to plan for the future, you need to understand your current financial position. What are incomes, expenses, assets and liabilities/debts? Your net worth is simply assets you owned minus liabilities you owed. The networth is calculated as under :-
(Insert Table Here)
Your net worth indicates your capacity to achieve financial goals, such as buying a home, paying for
university education, future medical expenses etc.
Develop Financial Goals
Your financial goals can range from acquiring assets, saving for emergency as well as investment for
your future financial security. The financial goals of an individual can be categorized as below:
a. Basic financial goals (food, clothing, shelter etc.)
b. Secondary or advanced financial goals (education, house, marriage, etc.)
c. Estate planning (Retirement planning)
Individuals can use a variety of investment, risk management, and tax planning strategies to meet their financial goals. These goals change over an individual's lifetime, and accordingly the financial plan should be reviewed on a regular basis for any modifications as per change in circumstances.
TIP: While making financial plans, one should first ensure a planned savings amount and then plan for
meeting expenses.
The wealth is not build overnight. One need to set specific financial goals. A good financial goal should be SMART i.e. Specific, Measurable, Action-oriented, Realistic and Time-based.
(Insert Chart Here)
Goal-based investing focuses on meeting goals that are personal and specific. The focus of this approach is arriving at future value of different goals and then pursuing these goals through asset allocation made for investments for each individual goal. To adopt this strategy when investing, one must plan as per one's age, risk appetite, financial situation and investment horizon.
Five Step Approach To Financial Goals
STEP 1: Identify specific financial goals
It is important to chalk out a proper plan to earmark each investment with a specific goal. It is crucial to prioritize goals and aspirations and estimate the amount of money it would take to fulfil them.
STEP 2: Classify goals into short-term, medium term or long term
Short-term goals are typically financial requirements that are expected to arise in time period ranging from a few months to one year. Goals like buying property, starting your own venture, or getting enrolled in a professional course can be a medium-term financial goal. Long-term goals may have a time horizon of eight years or more for example child's marriage or retirement course.
STEP 3: Decide upon asset-allocation
It is a strategy for investing your money into various asset classes such as equity and debt that would suit an investor's income and risk appetite. It is an investment strategy that aims to balance risk and reward - in the form of returns - by dividing a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.
Depending on your age, lifestyle and family commitments, your financial goals will vary. While allocating your funds, it is important to ensure that you distribute your investments across various assets for eg. in equity, bonds real estate etc. to benefit from diversification which helps contain risks and enhance the possibilities of higher rewards.
For example:
Equity: 40% of investments; Debt: 50% of investments; Gold: 10% of investments
STEP 4: Choose the right investments and diversification (within asset classes)
Arriving at the right risk-return combination and choosing the right asset allocation can seem difficult. For a longer term goal, it is advisable to focus on maximizing returns with diversified asset allocation.
Diversification:
It is a tool which reduces risk by allocating investments among various financial instruments, industries, and other categories. It aims to maximize return by investing in different assets, investments and areas that would each react differently to the same event such as those relating to the economy or markets.
Although diversification does not provide guarantee against loss, it is the most important component for
reaching long-range financial goals while minimizing risk.
> Don't put all eggs (Investment) in one basket (asset class)
> Diversification is doing investment in various financial instruments or asset classes.
> Goal is to find an appropriate balance between risk and return
STEP 5: Review and revise financial plans
To stay on track, regularly review the progress towards your goals and investments. Review the investments like stocks and mutual funds in your portfolio. Certain products may seem tailor-made for specific needs, but they may not be actually useful for one’s portfolio. Be aware of such investment options.
C. Choosing Investment Options & Understanding Risk
The investment avenues before the investor are fixed income securities, equity investments, mutual funds etc. Every asset class has its own risk and returns. Investments in equities are considered as higher risk investments as their returns are subject to performance of individual companies and general economic scenario. On the other hand, investments in the asset class of debt are relatively considered lower risk. For instance, Government bonds are considered to be effectively "risk free" due to the trust that government will not default on the repayment to investors.
Three pillars of investment - The investment decision by an individual is influenced by safety, liquidity and return. They are called the three pillars of investment.
i. Safety: This is about how well protected the principal and return of the investment are, For instance, if you lend 100 Rs to someone, will it be repaid on time? Or, is your capital of 100 Rs safe? Safety means your money invested is protected and there is every possibility that on the agreed date, or maybe even before, it would be returned on demand.
ii. Liquidity: The pillar of investment is the degree of ease with which you can encash or liquidate the investment? In the above example, it will be about how soon will you get your money back if you need it immediately?
iii. Returns: What is the returns you will get on your investments? It could be in the form of income, appreciation of capital invested, or both. Income means an investment's earnings in the form of interest or dividend payment. Appreciation means the increase in market value of investment over time. For example, if the market value is higher than the value at the time of investment, it is called appreciation or gain. In case the market value is lower, it is called depreciation or loss.
D. Returns from Investment
Returns from Investment can be described as a gain made by an investor on the investment he or she has made. The returns can be in two forms:-
(a) Regular income (b) Capital appreciation.
Regular Income - This type of returns generally comes in the form of dividend received from:
1. Equity Investment - You get dividends when buy and hold equity shares of a company and units of equity mutual fund.
2. Fixed Income Investments - This emanates from interest bearing Investments.
Capital Appreciation —When the value of initial investment gets enhanced over time and the investor benefits by selling part or whole of the investment at the enhanced value or price.
For example: An investor bought 100 shares of company XYZ Ltd at 50 Rs per share by paying 5,000 Rs. When the value of XYZ share increases to 65 Rs per share, and the investor sells 100 shares in the market, he or she will get 6,500 Rs (100 Shares * 65 Rs per share). The investor stands to gain 1,500 Rs from the initial investment. This is called capital appreciation.
E. What are Risks and Returns
Risk can be defined as the probability or likelihood of a loss occurring in relation to your expected returns from any particular investments. It is a measure of the level of uncertainty of achieving the returns as per investor expectations.
Risk and investing go hand in hand. The good news is that “risk” comes with the potential for “rewards” from investing — which is what makes the whole process worthwhile.
Tips:
Once you invest in any asset class you should monitor your investments and keep yourself updated about various market happenings to take corrective action.
Always check the potential risks and do proper due diligence when promised returns are unusually high.
Chapter 4 - Savings Related Products
In this chapter, we will discuss about the various savings related products available to the public. These include deposit schemes offered by banks, government deposit schemes, public deposits issued by companies etc.
A. Why to keep money in banks?
Drawbacks of keeping cash at home:
a) Unsafe: Money can be stolen or lost due to natural calamities.
b) Loss of growth opportunities: Loss of interest income
c) No credit eligibility: Deposit in banks create eligibility for taking loans.
Therefore it is beneficial to keep money in banks rather than at home in cash.
B. Banking
The commercial banks are regulated financial institutions as they deal with public money and trust. Commercial banks in India are regulated by Reserve Bank of India. Banks are required to go through mandatory inspection and audits at various intervals also by the Reserve Bank of India every year.
Bank deposits are comparatively lower risk investments. Banks offer various types of deposits, depending on the needs of the customers. Bank deposits are preferred more for their liquidity and safety than for the returns. It is possible to get loans up to 75 to 90 % of deposit amount from banks against fixed deposit.
Central Government deposit insurance scheme ensures that all deposits are insured by the Government up to a limit of 5 lakh Rs. So, even in case of a failure of a bank, depositors are assured that the Government will step in and return up to 5 lakh Rs of their savings in the bank.
C. Account Opening Process — Know Your Client (KYC) Norms
For opening any type of bank account, customers need to undergo the process of complying with KYC norms. KYC Stands for "Know Your Customer". The objective of KYC is to enable banks to know and understand their customers better and help them manage their risks prudently. The KYC documents generally accepted by banks are a) Photograph, b) Documentary proof of identity (copy of PAN Card/ Aadhaar Card etc.), and c) Documentary proof of address (copy of electricity bill/driving license/passport, etc.
D. Types of Bank Accounts
Savings Bank (SB) Account
Key Features :
- Low interest, however, highly liquid
- Facilitates payment mechanism through Automated Teller Machines (ATMs)
- No Tax deducted on Source (TDS) on interest on SB account balance, but taxable in the hands of depositor. (Upto 10,000 Rs Interest is tax free)
- Account can be opened in single name or joint names. In the case of joint account, the operation of the account can be by any one or done jointly. The accounts can be opened in the name of minors also wherein the accounts can be operated by guardians.
Fixed Deposit (FD) Account
Key Features :
- Involves placing funds with the bank for a fixed term at a certain interest rate
- Interest on FD is subject to Tax Deducted at Source (TDS)
- Senior citizens may get an extra benefit on the interest rate.
- Tenure and rate of interest on FDs varies from bank to bank.
Recurring Deposit (RD)
Key Features :
- A fixed amount is deposited at monthly intervals for a
- Account predetermined term
- Earns higher interest than savings bank account
- TDS applicable on interest accrued or earned
Special Bank Term Deposit Scheme
Key Features :
- Tax savings scheme available with banks
- Relief under Section 80C of the Income Tax Act, 1961
- Term deposit of five years maturity
- No premature withdrawal allowed
E. Digital Banking
In the modern era, transaction including payments, fund transfers, buying goods etc. all take place in digital platforms such as mobile phones and the customer can do the transaction from any place. The various digital modes of transferring funds are mentioned as below:
NEFT (National Electronic Fund Transfer)
Key Features :
- Transfer of funds from one Bank account to a different account of another Bank using beneficiary's account number and IFSC Code (Indian Financial Services Code, a unique code assigned to each bank branch)
- Charges for transfer may differ from bank to bank.
RTGS (Real Time Gross Settlement)
Key Features :
- Transfer of funds from one Bank account to a different account of another bank on a real time basis facilitating high value transactions using beneficiary's account number and IFSC Code
IMPS (Immediate Payment Service)
Key Features :
- Transfer of funds from one Bank account to another facilitating instant fund transfer.
- For transfer through internet banking, beneficiary's account number and IFSC Code are needed and through mobile banking beneficiary's MMID (Mobile Money Identifier is a 7 digit number issued by bank to the customer) is needed.
Unified Payment Interface (UPI)
Key Features :
- Transactions to be done through any smart phone using VPA (Virtual Payment Address) facilitating 24 x 7 transfer on a real time basis.
- One needs to download UPI-enabled bank app and login using bank details.
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