Jun 13, 2012 02:40 PM IST | Source: personalfn.com

How to improve your personal finance literacy

The ultimate goal of improving your personal financial literacy is to make smart money decisions and improve your financial well-being.

How to improve your personal finance literacy

The ultimate goal of improving your personal financial literacy is to make smart money decisions and improve your financial well-being.

Financial knowledge and awareness can help you take mature decisions on every topic of personal finance from your expenses, savings, budgeting to using plastic money wisely. Each of these decisions has an impact on your finances overall, and hence the ability to make good financial decisions is very important.

For example, many people lack the resources to help them rebound from the downturns of the type witnessed in 2008. This would have been avoided by having access to safe savings products by way of a contingency fund. Creating a contingency fund of 6- 12 months of your living expenses is good sense, and is a good financial habit.

Many investors were made to believe that insurance products such as ULIPs are the first place they should be investing their surplus funds, however this is a classic case of mis-selling done by agents to investors who were not aware of the product features. Had these investors been aware of the charges in the product such as the premium allocation charges, surrender charges, and so on that impact the returns of the product and can have a negative impact on the financial life of the product owner, they would not have opted for such products. This is where awareness and strong personal financial literacy would have helped.

Most of us will make many financial decisions including saving for retirement, managing our credit wisely, budgeting, tax and estate planning, insurance etc. which will affect our lives. Each of these decisions is prompted by our own individual needs.

To help make profitable financial decisions, it is necessary to understand the basic purpose of investing.

Example: While most consumers understand that retirement implies the end of work-related income, they may often fail to understand that as a person grows older; his ability to recover any financial losses goes down. It is this knowledge that can truly inspire the decision to save so that you take less risk with your retirement funds.

Improving your personal financial literacy will not only enhance your financial freedom, but also over time provide financial security and stability.

So how do you improve your personal financial literacy?

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1. Start by building up your financial awareness- you can read personal finance websites and read the financial newspapers.

2. If there is something you want to understand about a product but don’t have anyone whom you can ask, you can always do an internet search on the product and read up on its features. But be sure to access the right information from a website which verifies its information, such as a news website or an independent research website. Avoid reading personal blogs as these are simply an amalgamation of people’s opinions and may or may not be based on fact.

3. Know Your Personal Financial Ratios

Debt to Income Ratio =

          Total monthly outgoings on liabilities 
         Total monthly income from fixed sources

Ideally, your debt to income ratio should not be higher than 30% as this means you are straining your income.

Savings to Income Ratio =

          Total monthly savings 
          Total monthly income

Ideally, you should be saving 10% of your monthly income for a rainy day.

Contingency Reserve

Contingency Reserve = 6 - 12 months of living expenses

You should set aside 6 to 12 months of living expenses as a contingency fund to be used only in times of emergencies. This should include any EMIs that you may have.

Once you implement these simple personal finance rules, you will find that your finances are more in control and manageable.

4. Speak to your unbiased Financial Planner to give you an honest view on whether a particular financial decision is the right one to make or not.

Remember, the more information you gather, the more you will have on hand to make an informed financial decision. Every single informed decision you make will go towards making the most of your financial plan.

PersonalFN is a Mumbai based Financial Planning and Mutual Fund Research Firm.

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