Let's Talk Money: You've Worked Hard for It, Now Make It Work for You

by Monika Halan

the commission-driven world of finance has been deliberately obfuscated for the layman. Navigating through the jargon can feel like trying to cut through a dense thicket with a butter knife.

Your money oxygen mask in times of uncertainty

What the pandemic taught us about our money

My learning was that I can up my saving target sharply the day I decide to go back into a lockdown mode even once we are out of this situation.

The second lesson I learnt was that the emergency fund amount needs to be recalibrated according to the age, stage and nature of work.

The need for zero-risk money needed for survival in a safe bank (PSU or one of the large private sector banks) suddenly become manifest. My recommendation of emergency funds has now changed. For those forty years and below in secure jobs, you are fine with six months of living expenses in an FD, but as the age increases and as the riskiness of the job goes up, ramp up the fund to reach two years for older cohorts in jobs that are not that secure.

The third lesson was that we need to rethink risk. First half of 2020 saw a private sector bank freeze deposits for a few days. During those days it was not that clear what the final outcome would be. It saw a huge market crash. It saw a fund house shut down six debt funds, freezing investor money for the near future. It saw salaries go down. It saw jobs at risk. It saw firings. Nothing felt safe. And in this panic came the lesson that there is no financial product without risk.

The fact is that there is no one safe haven for your money. Each investment comes with some risk and you have to decide which one you are able to take.

asset allocation is not an option, and even high-risk appetite people like me, need to be less risk happy. And those with very little risk appetite, need to go for a more balanced portfolio. We need to understand the difference between risk appetite and risk capacity. Risk capacity is the ability to take risk. Risk appetite is the willingness to take risk.

Capacity is about your age, stage, number of dependents, confidence about your ability to keep generating income for a long time.

Appetite is the desire to take risk. This depends on how well you understand money, finance, your own skills, your own ability to manage your portfolio or ability to hire a planner to do this work.

Ideally your total fixed obligation-to-income ratio (FOIR) should be 30 per cent or less. This means that all your EMIs put together must not be more than 30 per cent of your take home money. If your take-home is Rs 1 lakh, your EMIs are no larger than Rs 30,000. Remember, this is a maximum. I would be much happier with a 15–20 per cent ratio. Imagine a salary cut of 25 per cent and then look at your paying capacity.

The way we behave when we have dependents is very different than when we don’t.

You are doing OK if … you have between six months to two years of emergency funds in a mix of FD in a scheduled commercial large bank – both public sector and private sector banks are fine – and very conservative debt funds; your loans are less than 30 per cent of your take-home salary; you are increasing safe assets as you age; you have your own medical cover; you have your wills in place; you are building a second and a third career even as your work your current job.

THE MONEY ORDER

‘what to invest in’ is not the first decision we should take – a mistake that we all make, pushed as we are by a sales commission–driven insurance industry or a next-new-thing–driven mutual fund industry. So, how should we think about our money box? A good money box is one that allows you to streamline your cash flows. It builds in safety nets for preserving your savings in the face of an emergency – typically a medical emergency, a job loss, or death of a salary-earning family member.

why the government’s need to finance its deficit leads to you buying toxic products. Yup, there’s a link. You will understand why the global financial sector wants you to feel stupid. You will understand how you are actually doing the best you can in a marketplace that is full of sharks. You will see that you are not a money dummy.

the current ‘buyer beware’ in the financial sector – or transferring of responsibility to the investor of buying the right financial product – is a regulatory failure. It is not unlike a car vendor flinging open the bonnet and saying: ‘Go do your due diligence and ensure this car is safe.’ Asking an average person to understand concepts of present value, future value, real return and so on is no different from asking him to buy a car after ensuring that the engine is safe! You will understand why the regulatory changes under way are so important for your future.

DON’T STASH THAT CASH!

Everybody has money to save – from the poor woman who sells veggies to you on the roadside, to the tycoon driving by in his Bimmer – we just don’t know how to look for it. The key to finding the money to save and invest is to have a good cash flow system.

The goal is to separate out money according to its function so that the brain is better able to map it. I do this using three boxes for the three functions of money. These are income, spending and saving. If we can separate the money into these three boxes each month, we’ll be in better control.

You and your spouse must have your individual Income Accounts. The Spend-it Account is a joint account into which both credit equal amounts for the monthly spending. Each partner has his and her Invest-it Account in different banks. These can be joint, but the primary holder should ideally be the person in whose name the investment will happen. Don’t do anything else. Don’t think about investing. Just get these three accounts in place. Once they are, start the exercise of moving money out on the day your salary hits the Income Account.

Two things happened when I began doing this. One, I began to question my spending. Once you realize how much is going into your Spend-it Account, you can’t hide from yourself any more. Two, as the Invest-it Account begins to build up, you see how much your saving capacity is.

What stops you from dipping into your Invest-it Account to pay for your spending? This is where behavioural economics steps in. Putting a label on money prevents people from using it for any other purpose. This is called ‘mental accounting’ and it means that we like to separate our money into separate accounts according to intent, and dislike using it for any other use.

Budgets are boring. Instead of mapping the small expenses, have these rules of thumb in your mind. If you are going consistently over these limits, you need a relook at where your money is going. Eating out, going to the movies, travelling and buying gadgets are the big budget breakers. Go for a balanced, rather than a hard, spending diet. Hard diets fail. You are doing OK if … you have a three-account system that separates your income, spending and savings; your spending on living costs is no more than 45–50 per cent of your take-home income; your EMI payouts are no more than 25–30 per cent of your take-home income; your savings are at least 15–20 per cent of your take-home income.

EMERGENCIES NEED A FUND

Keeping money ready for an emergency is important. Not only do you not have to worry about the money when you need it but it also frees up money for long-term investments.

‘Why don’t you want to invest for the long-term?’, the answer almost always is ‘What if there is an emergency? I won’t be able to use my own money if it is tied up in a long-term investment.’

The unwillingness to take risks also comes from this fear of not having the money when it is needed. Therefore, people stay with money in near-liquid products or bank deposits that are easily cashed if need arises. It is a reasonable fear. We all do have situations where we need the money – it could be a medical emergency, a job loss, some disability or health issue that prevents us from earning. But there is a way to keep money aside for such emergencies and then free up our savings for the future.

You’d typically need money ‘midway’ under two circumstances – planned and unplanned events.

There are some events that we can look after through insurances, but there are some, like a job loss, that we need to prepare for. We all need an emergency fund. This is a fund that will only be used in case of a financial emergency.

How much do you need? A rough rule of thumb says keep aside six months’ to two years’ living costs. Include everything in it – rent, EMI, school fees, utilities, premiums, credit card charges, club memberships, whatever. The cash flow system that we created earlier will tell you what your monthly transfer to your Spend-it account is. Multiply that by six. Remember this is an average; you can increase or decrease this amount depending on your personal situation.

I keep a year’s expenses in a clearly marked emergency fund. We’ll see how this allows me to take much more risk with my investments than I would otherwise.

Where do you keep this money?

We want to be able to access this money quickly with no loss in value. The worst thing you can do is leave this money sloshing around in your savings deposit. At the time of writing this book, State Bank of India gave 2.75 per cent interest on the savings deposit. You need to move it to a place that is not that easy to access, but yet is liquid enough to be of use when you want it and gives a r...

This is your entry-level product – setting up an FD with your emergency money in it. If you are banking with a bank that allows flexi-FDs that allow you to sweep out just the amount you need, rather than breaking the entire deposit, go for that. Else split your emergency fund into smaller FDs so that you don’t have to lose the interest on the entire deposit.

People familiar with mutual funds can use what are called short-term debt funds to build an emergency fund.

Understand debt mutual fund products before you begin to use it for an emergency fund. There are several advantages to this product. It earns you a better return, is more liquid than an FD and can have a lower tax incidence than an FD if you plan its use well. The higher post-tax return as compared to a bank FD makes a debt fund a great choice for an emergency fund.

This is the go-to fund when disaster strikes in the form of a job loss or death. Even if you have a life cover, the money takes time to come, but the ongoing costs don’t stop. I can’t stress the importance of this fund. It is the difference between slipping into disaster and staying afloat. You are doing OK if … you have six months’ to two years’ living costs in an emergency fund; you are a double-income family with no dependent parents and have three months’ living expenses; you are a single-income home with dependent parents and have a year’s living costs in an emergency fund; you are in your 50s and have two years of living expenses in this fund; your emergency fund sits fixed deposits or very safe debt funds.

BUILDING YOUR PROTECTION

What is a medical cover? Each time we go to the doctor for a viral fever, we don’t really think of the cost too much. The fee is affordable because we choose our doctors given our own spending power. The prescription medicines he gives also don’t break the monthly budget. But when you have something more serious, like a surgery for a liver infection or a heart attack or a knee replacement, the costs can be significant. One way to pay for these costs is to dip into your savings. We do hoard money in our bank deposits to take care of just such an emergency, don’t we? But if we transfer this risk to somebody else for a small fee, then we don’t need to dip into our investments. This transfer of the risk happens when you buy a medical insurance plan where, for the price of a premium, you buy a much larger ‘cover’

Getting a good medical cover is probably more important than buying life insurance – you’re more likely to go to hospital with an illness or accident than die. But identifying this ‘good’ policy is so difficult.

Do I need cover? My office covers me Yes, you do. I always recommend buying your own policy even if you are covered by your office, especially if you are in your forties.

other time you see reality biting is at retirement. Along with the farewell party, you bid farewell to your medical cover from work. Getting a cover at age sixty is difficult. Lifestyle diseases like hypertension and diabetes may have set in, reducing the choice set of available medical plans. Companies are reluctant to cover older people, and for older people with a ‘pre-existing’ disease, the reluctance is even stronger. Also, most insurance companies will not cover your ‘pre-existing’ diseases and medical costs related to a pre-existing disease for a maximum of four years.

How much do I need?

‘How much cover do I need?’ depends on where you live, and what kind of hospital you want to go to, and what kind of privacy concerns you may have.

But we can still work with some rules of thumb. You need a basic cover of Rs 3–15 lakhs per person. Use the Rs 3 lakh number for smaller towns and less posh facilities, and the Rs 15 lakh number for metros and all the bells and whistles. For a nuclear family it makes sense to get a product called a ‘family floater’ that allows the insurance cover to whichever member of the family that needs it.

For the years in which you make no claim, the outflow of premium feels heavier and heavier. But it takes one stint in hospital to see the usefulness of the premium you have paid.

What policy do I buy?

That’s the most difficult question of all, and one that everybody wants an answer to. But there are no easy answers. I’m no newbie in finance, but I have to tell you that when I was in the market to buy a policy, I had to call a financial planner. The complexity of products, their features and the fine print in policies is...