Investors are more financially savvy today. However, some misplaced beliefs remain
Planning your finances can be akin to negotiating a minefield, of money myths. Over the years, we have systematically busted one myth at a time to make the life of you, the investor, easier. However, the rot of misinformation runs so deep that even some personal finance professionals spout fallacies without realising how wrong they are. This week, we tackle seven misconceptions about money that if ignored, can jeopardise your finances.
Pay long duration loans first
A common trait among many finance professionals is to recommend paying off of long duration loans quickly to save on interest costs. The fallout of such advice is people continue to service high-cost short-term loans like personal loans while prepaying lowcost long duration loans like housing loans. Tanwir Alam, Founder & CEO, Fincart says, “If you consider tax benefits, the real cost of a housing loan will be less than 6% for people in the 30% tax bracket. It is a mistake to repay that and not the personal loans, which cost much more.”
Risk is not for the middle class
This myth warns the middle class to avoid risk at all cost. However, shunning risk now can have serious repercussions in future. This is because this income group has limited resources and will not be able to meet goals by relying on low risk and low yielding debt products alone. In other words, investors from this group must park a part of their portfolio in growth assets like equities that can generate higher returns. “People with limited resources can’t afford to ignore equity. Else, inflation will eat into their corpus. The only question is how much this equity allocation should be,” says Suresh Sadagopan, Founder, Ladder7 Financial Advisories.
On the other hand, high net worth individuals (HNIs) can ignore equities and remain fully invested in debt if they want to, without affecting their goals.
SIPs are risk free in long term
While all finance professionals say SIPs average out investments and thereby reduce risk, some go overboard and try to project SIPs as the weapon to eliminate risk altogether. “SIPs will never be able to eliminate risk as it is just a tool and not a product,” says Amol Joshi, Founder, PlanRupee Investment Services. Since the returns from a few good years will compensate for the bad years, equity investors end up getting decent historical average returns. However, long term SIP investments can also give negative returns if the stock market remains in a bear grip over a very long time.
Retirement planning is all about money
While most people underestimate the risk of surviving long years and exhausting the retirement corpus, creating an adequate corpus that will last till the end is the corner stone of retirement planning. “Since retired life can stretch to 30-40 years, you need to balance the money part with other activities. Use a part of the free time to revive hobbies, rejuvenate the friends’ circle and spend time on social responsibility etc,” says Joshi.
Retirement planning should be split into two parts—the time till you expect to maintain reasonable health and beyond. Retirement planning should also have a clear plan in place for the second stage when you require support. If you are not sure of the support of your children, it is better to identify retirement homes from now itself.
Family budget should be detailed
The myth about must having a detailed budget in place needs to go. There is nothing to stop you from creating a family budget with broad guidelines. “Budgeting doesn’t mean that you have to write down everything. Treat budgeting as a broad framework and split the outflows into three buckets—expenses, repayments and savings,” says Joshi. What is there in each bucket will vary depending on life stages and income levels. For example, expenses will be less than 1/3 for families with very high incomes. Similarly, the repayment buckets will be empty for people without any loans.
To identify how much should be in each bucket, identify your broad expenses first. “Identifying expenses is not that difficult and if the husband and wife sit together, they will be able to do it in 15-20 minutes,” says Sadagopan. What they need to discuss and finalise is a budget for discretionary expenses like eating out, movies, etc. and annual expenses like travelling, etc.
Straying from budget will upset financial plans
If you repeatedly fail to stick to your budget, you will impact your long-term goals. However, budgets are broad guidelines and overshooting every few months is normal. If there is a budget breach, find out from which bucket you have spent excess from. For example, meeting your sudden urge to buy a smartphone by giving up on the annual travel plan is fine. However, there would be a problem if you bought the phone by breaking into investments for critical goals like your kid’s education or your retirement planning.
A budget breach can also happen because of sudden and necessary expenses. For example, you want to gift a gold chain for your relative’s marriage because she did the same for your marriage. You can dip into the emergency fund for situations like this. However, make sure you don’t touch the emergency fund for expenses that can be postponed, like buying a smartphone.
The financial adviser will take care of it all
Most investors assume that once they hire an adviser, their financial planning related work is over. What investors should understand is that planning is just the starting point and not the end. It is also not safe on the part of investors to blindly trust advisers. Investors should always remember the ‘caveat emptor’ rule. “Investors handing over the logistic part to the adviser is fine, but they need to keep the decision-making part with them,” says Shah. Please note that appointing someone as your financial adviser itself is a big decision but even after that, investors need to drive the engagement with the adviser. As per the Sebi RIA rules, active involvement from the client is compulsory. NARENDRA NATHAN
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