A budget will help you ascertain if you are living within your means or stretching your finances when you cannot afford it
We had a few youngsters who were perpetually in debt.
They didn't think it is important to clear off the debt. After repeated sessions, we figured out they are not mentally prepared to clear the mess.
Eventually, we had to let them go because there was no point in trying to drive home the same point.
There is a section of people that believes it knows all. These are educated people with family backgrounds where money was discussed. It is a clear case of a little knowledge becoming very dangerous.
Another set of people has deep mistrust when it comes to listening to anyone on financial matters. This could be because of a negative thought process or due to some deep-rooted psychological issues.
Most people don't realise the kind of turbulence servicing debt can cause in their lives. They think they can go on repaying without ever having to bother about the uncertainties in the future.
Financial experts have many stories – some funny, some sad — to recount about these people. Earlier, when people used to come to financial advisors, they would have some money in their account. These days, they have only debt.
I asked this young guy how he managed to run up so much debt and he said his friends have done 'even better'. Needless to say, the guy didn't believe in tightening his belt (another old-fashioned expression) and parted company with the advisor.
Another sob story is about a couple who had huge debt but refused to listen to the advice of their financial planner, who suggested they repay more rather than invest money in the stock market.
Sadly for the couple, the market fell drastically and one of them also lost the job during the economic slowdown in 2008.
Some Things Never Change
Even if one studiously cuts out worn-out expressions like 'saving for the rainy day', 'tightening the belt' and so on, one cannot emphasise enough the importance of certain rules of money management, say experts.
Sure, depending on the expert, the tools may differ. Some may run you through an excel sheet or a power point presentation and give you numbers for saving, investment, holiday, etc.
However, the basics remain the same. And one such basic is having a budget. Prepare a budget and follow it religiously. When you try to stay within a budget, certain numbers would call for your attention. That will tell you whether you are stretching yourself unnecessarily or for a genuine reason.
The next step is to identify major financial goals in your life, such as buying a home, child's education, your retirement, and so on. Prioritise your goals and try to quantify them.
Simply put, you should project how much money you need to take care of your financial milestones many years away from now. You should always use the actual numbers and inflate it by a certain percentage to account for inflation over a period of time. This will give you a clear idea of how much you have to save and how much you should earn to reach the target figure. This, in a way, will also help you to decide on the investment vehicle.
For example, if your target corpus requires double-digit returns, you have to think of taking extra risk and investing in the stock market. If you need to grow your money at a smaller pace (in other words, you have lots of money to invest), then you don't have to take any risk and invest in safer avenues liked fixed income instruments.
TACKLING DEBT
Now, you would probably wonder why these experts are talking about the need for a budget and identifying financial goals when you are actually troubled by debt. Well, the exercise would help you realise whether your debt is within manageable limits.
For example, if you are really neck-deep in debt, it is very unlikely that you will stay within your budget or will have enough money to invest for your financial goals.
If you are going to repay your debt for 10 or 15 years, it is very unlikely that you wouldn't have a situation where you would find it impossible to service it. The reasons could be beyond your control. For example, it could be a career change, family crisis, medical emergency. The so-called smart dudes of the new generation think they have salary of 13 months, as they can roll over money for a month with their credit cards. But spending with your credit cards requires higher discipline. This is because it is easy to fall into the debt trap if you don't clear your dues every month.
All one needs to do is to ask whether you actually need a credit before you go for it. You should take a loan only if there is no way out. It has to be need-based.
Sorry, it may sound old-fashioned, but this is the only way to distinguish good and bad credit. For example, if you are taking a loan to tide over an unexpected financial crisis, it is fine. But it is definitely not cool if you are taking an expensive loan to buy an LED TV.
Another tricky area is to figure out whether one should continue with regular investments when one is faced with huge debt.
You should be able to take a call on it. For example, there is no point in earning 8% in an FD when you are paying 30% interest on your debt. It all boils down to the planner or advisor. You can, for instance, take a more humane approach and decide whether you should aggressively repay your debt or have some legroom for comfort.
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