Master your money

The savants are right, the answers lie within. But we keep seeking them outside, and that causes all the problems: Instead of answers, we come up with more questions. Our financial dilemmas are a perfect example of this paradox: Why is it good to invest in equities though you are scared of risk? Why is too much handy cash bad when it feels so good to spend? Why can't you put off planning for retirement when it is so far into the future?

Some answers are easy to tackle, others defy the rule book. Perhaps because the financial world is in a state of perpetual flux and the rules themselves keep changing. So the commission structure in mutual funds has gone and that in insurance is set to follow suit. The loan rates are changing fast and even the good old bank accounts are undergoing a revamp; interest rates will now be computed on a daily basis.

These are external factors riddled with opportunities and it's our response, comprising acumen and instinct, that dictates our success at exploiting them. While acumen is easy to acquire, it doesn't take psycho analysis to know that instinct resists change. You would rather shut out the change in the financial world A.R. (After Recession) and stick to the old economic order. But no matter how much you crave status quo, you must adapt to change, which requires that you be aware of your relationship with money.

For this, you need to confront your financial personality, discover its mainstays, quirks and fetishes and then work around the shortcomings in your personality without changing it dramatically. After assessing the patterns of common mistakes made by investors, Money Today has formulated strategies for four financial personalities: spendthrifts, debt mongers, dodgers and radicals (Take the quiz Know Your Investor Type).

The Spendthrift
Let's take the case of Kolkata-based Prithviraj Dasgupta, a 34-year-old entrepreneur, who is not sure what compels him to spend 70 per cent of his monthly income. He just spends it. "I have cash in hand and there is nothing to do with the money. Spending has become a habit," he says. (See case study).

Although there is no arbitrary limit of expense to qualify as a spendthrift, you should worry if expenses, excluding rent, exceed 50 per cent of your net income. Dasgupta spends about Rs 28,000 a month on clothes, accessories and fine dining. By spending almost everything he earns, he is losing out on precious time to create long-term wealth. Says Deven Shah, Business Head, Money Mentor: "Such people have a low sensitivity to the pain of parting with money."

The financial fallout of high-rolling extends beyond messing up the cash flow. For one, because there is no surplus, spendthrifts invest randomly and do not align investments with their goals. As a result, there is an inadequate corpus for important events like children's education and retirement.

High-rollers have little idea about what eats up their income. So, instead of being prepared for it, they are shocked when they come up short. Not that this tames the shopping monster. A spendthrift would rather let an insurance policy lapse and use the money to finance a short-term need. Or else, loans and credit cards come to the rescue. This is why they are more likely to become debt mongers in future. Dasgupta sums up the effect of extravagance accurately: "My finances are very disorganised. I don't know how to start putting things right."

The answer is, in the mind. If you are a spendthrift, start with acknowledging that you must spend less. Make a list of your expenses and classify them as necessary and discretionary. Next, sort out those expenses which conventional wisdom does not consider necessary. For instance, dining out twice a week is not a necessity. You must stick to the budget you have made. However, going to a mall with the resolve to spend, say, less than Rs 2,000 is not the way to do it. A better idea is to go to the mall with less than Rs 2,000 (and no plastic money) in your wallet. No money means no expenses.

What if you are motivated enough to go to the bank and withdraw cash for what you want to buy? Make sure that there is no money in the bank for such indulgences. This is the most important rule of planning for spendthrifts: Income minus saving equals spending. The idea is to hide the money from yourself so that it can be used in a more financially prudent way.

For this, first set your financial goals and figure out how much you need to save for them. Match your surplus with the amount of investment required every month. If the difference is too high, go back to the budget and cut back further. To take your money to the final hiding place, investments, use automatic bank transfers. Opt for SIPs in mutual funds and ULIPs for the day after your salary is deposited. You can also transfer money to debt investments for building safe havens.

For building an emergency fund, one option is to shift some money to another account and hand over the ATM card and cheque book to a trusted friend in the same city. In addition, cut up all credit cards. A great tip for highrollers comes from an unexpected source, Oscar Wilde, who said, "I can resist everything but temptation." In your case, keep it at bay.

The Debt Monger
But if you can't tame your urges, very soon you will find yourself shopping for debt. And when that becomes a habit, your transition into a debt monger will be complete.

A typical characteristic of people with heavy debt is that they live in a state of denial. As long as there is enough money for expenses and payouts, all is well. Take the case of Delhibased Potnuru Kiran Kumar, 28, who doesn't consider high debt as a problem. The EMIs of his personal (from his engineering college days) and education loan comprise 55.06 per cent of his net income, but he is not worried. "I am not concerned about savings. There is a lot of time for it," he says.

Along with the two EMIs, Kumar is also rolling over a credit card bill of about Rs 27,000. His monthly income of Rs 25,000 is not enough to service all three forms of debt simultaneously. So the month he pays a part of the credit card bill, he foregoes the EMI of the personal loan. In fact, after three years of servicing loans, Kumar claims to have mastered the art of managing his cash flow around the payouts.

Says Swapnil Pawar, Head, HNI Solutions, Karvy Private Wealth: "Such investors paint a rosy picture of the future, where everything moves in their favour." In addition, most debt addicts have an "external locus of control", a phrase used by psychologists to explain the tendency of shrugging responsibility. Such people refuse to accept that high debt is a result of their actions and, consequently, do not think they can resolve the situation.

Therefore, planning for debt addicts must begin with convincing them of the problem. Pawar offers a simple formula: if the debt used to build depreciating assets is more than 30-50 per cent of your net income, accept that you are in trouble. The second step is to ensure that you do not add to the burden. If credit cards are a problem, cut them up completely. If you are planning to buy a new gadget on instalments, give up the idea. In fact, do not think of even good debt like a home loan till the total debt is within limits.

To shatter the false sense of wellbeing, Pawar suggests that you chop off 10 per cent of your net income while making any calculations. Next, add a buffer of another 10 per cent to your budget. This strategy has dual benefits: your debt affordability drops sharply and your cash flow automatically generates a monthly surplus. The investment rules for debt mongers are the same as that for spendthrifts: invest first and spend later. But before you tie up your money in long-term investments, consolidate your debt.

Start by ranking your debt according to the rate of interest. Typically, credit cards will top the list, followed by personal loans, car loans, etc. This is the order in which you must repay your debt. If you have investments that earn lower returns than the rate of interest of your loans, withdraw the money to prepay the debt.

However, make sure that the money is not needed in the next few months. In case you have different loans from the same bank, request it to combine them into the loan with the lowest rate. This strategy is called snowballing of debt and reduces your net interest outgo. If possible, do the same with credit cards, too. However, scrutinise the bank's offer closely to ferret out any hidden costs that may upset your plans. Though borrowing to repay another loan is a strict nono, experts make exceptions if the interest differential between the two loans is significantly high. So, don't close this option either.

Most importantly, do not break one debt cycle to be caught in a new one. When Kumar was asked what he planned to do with the money freed on foreclosing his personal loan, he replied, "I will spend more on entertainment. I also want to take a home loan next year. Of course, I will save a little." If you are as comfortable as Kumar with debt, try to refrain from taking a needless one for at least a year. Once you live a stress-free life, all thoughts of financial masochism will be banished.