On the eve of Independence Day, HT puts you on the path to economic freedom
1. Calculate your net worth
What is net worth?
Find out the value of all your assets — provident fund, small savings, house, mutual funds, gold, cash. Now deduct all your debts — home loan, car loan, credit card debt. That's your net worth.
What should it be?
The value of your assets should be more than the debt you hold. It should be growing. And it must reflect the investment risk you're willing to take.
HT TIP: Calculate your net worth every year. Apart from telling you exactly where you stand, the exercise is enriching — most people realise they own much more than what they thought .
2. Write your financial goals
What are financial goals?
Any major decision of your life that needs money for its fruition — buying a house, a car, planning for your children's higher education, luxury travel or retirement — is a financial goal.
How do I work them out?
If you are 27 and plan to own a house by the age of 30, you need to plan for its down payment. If the price of the property is R40 lakh, you may need around R6 lakh for making the down payment, considering a bank finance of 85 per cent on the property value. Similarly, you can plan for your children's higher education or for your retirement.
HT TIP: There is a difference between "dreams" and "goals". Dreams are fantasies, but financial goals are very real. Make sure it's goals you're setting.
3. Protect what you have
Protection? Against what?
Primarily death. Or, to be accurate, the income that will stop if you die. Before you begin your journey to financial independence, you need to protect what you have using life and non-life insurance — the first financial product you should buy.
How much life cover should I buy?
If you have a family, a pure "term" cover — the cheapest insurance policy that covers you for the highest amount — is your first financial shield against death. If you are 30, your annual expenses are R2.4 lakh, your liabilities are R40 lakh (on a home loan, perhaps) and your assets are worth R5 lakh, you need a cover of R80 lakh.
What else should I protect?
Your health — with healthcare costs rising, a simple procedure can set you back by Rs 1-5 lakh.
HT TIP: Make sure that your insurance policy has an assignee and a nominee.
4. Wealth creation
Wealth? I don't even have a decent income
The earlier you distinguish between income and wealth, and turn your salary into wealth, the better. It is a myth that you can't build wealth on a modest income. The mantra: start early and use the magical power of compounding to serve you (See table in "A do-it-yourself guide to making your crores" below).
How much wealth do I need?
After you've finished with two of your most important responsibilities — bought a house and educated your children — you need money to sustain yourself after retirement. Apart from maintaining your household income, you need to plan for wealth's Enemy No 1: Inflation. At 30, if your monthly home expenses are Rs 15,000 and the inflation rate is 5 per cent per annum, you would need close to Rs 65,000 per month to meet these needs at 60. If you invest Rs 2,900 per month for your retirement that grows at a CAGR of 12 per cent, you will accumulate Rs 1 crore — sufficient to generate, at a conservative rate of 8 per cent, a return that can meet your living expenses post-retirement.
HT TIP: If you have been unable to start early, you might need to take a greater investment risk. But prepare yourself psychologically.
5. Keep your debt under control
Debt? You mean my EMIs?
Yes. You need to be very responsible towards repaying your loan liabilities. Never expose yourself to loans that go beyond your means to service. Experts say that no more than 40 per cent of your net income should go towards servicing all your loans (home, car, credit card).
Further, if you are earning 8 per cent returns on your fixed deposit and paying 14 per cent interest on your personal loan, it is advisable to break your fixed deposit and pre-pay the loan.
Similarly, always make your credit cards payments on time. If you miss on your payments, you may end up paying an interest at the rate of 3 per cent per month or more than 40 per cent per annum.
HT TIP: While debt is best avoided, in times of high inflation, taking a home loan is smart — the price of your property will rise long term, while inflation will reduce the real cost of your debt.
6. Prepare your will
But I'm still young. What do you mean?
Age has nothing to do with making a Will, assets do. You might believe that all your assets and property will automatically pass on to your spouse after your death. Not true. Depending upon the law under which your marriage comes, children and relatives can also stake claim to your property.
Oh my god, what should I do?
Write your Will and ensure that your loved ones don't fight among themselves over your property. Experts suggest that a Will must be registered before a sub-registrar to ensure its legality. Your Will has to be signed in the presence of two competent witnesses who are above 18 and are of "sound mind".
HT TIP: Ensure that your witnesses and the executor of the Will are younger than you and have a lower probability of dying before you. Also make sure that the asignees/nominees of your investments are the same as the beneficiaries in your Will.