My Finances

My theory of financial prudence

 

I am a young earner, and my view of finance is skewed only for the young, who have a longer time frame for investments. Though I said these words of caution, I will like to reaffirm that the basic tenets of my financial wisdom can be applied by anybody belonging to any age category.

First of my principle is to divide the net home-take after taxes (not gross income), into three equal parts. Of these three parts first part should be allocated for family and personal expenses. Second part should be allocated for savings. These second part will grow in time to make a cash cushion. Third and last part should be invested to gain a higher return than achieved by savings.

Second principle is to make the cash cushion sufficient enough to fulfill the family and personal needs for at least six months. This is very important because if one loses job or income suddenly stops, then he can manage for next six months. This buys him time to solve the problem.

Third principle is about debt. Never think there is free lunch. Some ads say like “Save while you buy”. It is ludicrous, because when you spend, you lose money. You can never save that way. Always avoid credit cards. They charge very high interest and if you fail it becomes a bad debt. Only take loans for making money. That is take other people money only when you are sure that my investing that amount you will earn and can repay back with interest. Never take a loan to meet personal needs.

Fourth principle is about taking a protection against future uncertainties. This means buying insurance. One should always have a sufficient heath cover and life cover. Life cover should be approximately five times of your net annual income.

Fifth principle is about maintaining a discipline in investing. One cannot time the market so it is essential that one should regularly invest in small amounts. This averages the cost of purchase and essentially reduces risk.

Sixth principle is about diversification of portfolio. One’s portfolio must have a mix of debt, equity and gold. Gold should be at most 5 % of investments. It provides guard against rising inflationary pressures. But investing more essentially means locking a huge sum for essentially lesser returns.

Seventh principle is about quality of investments. Investments should be made only where you are sure of getting it back. Gambling should not be done. You should always park money in safe debts. In equities, purchase only those companies about whose business model you are sure of and in whose management you have faith. Never purchase based on rumors. If your broker encourage you to day trade never get involve. It takes a great expertise to succeed in day trading. Leverage against your risk with time. It has been seen if money is invested for 20 years in good profitable companies it always gives higher return than any other asset class.