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Financial Resolutions for the New Year

Divide expenses between essentials and discretionary spending

December 28, 2021 / 09:52 AM IST

As we approach the New Year, we see people making resolutions of various kinds, more often than not about their physical or professional lives. We believe focusing on financial health is important as well.

Here, we list some key resolutions that will make an individual financially healthy.

Assess your financial condition

To begin with, we suggest every individual check the following ratios: net-worth, leverage, loans to assets, savings ratio, savings to annual income, liquidity, cash to assets and solvency ratio – equated monthly instalments vs. annual income.

This would help one evaluate not only their financial position, but also lay the foundation for taking the right financial decisions in future.

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Prepare a budget for the year

Start by listing the various expense heads that one has to incur in day-to-day life. Divide expenses between essentials and discretionary spending. Match spending with income and you would know the amount of surplus/deficit and the time of the year (and the reason) it is likely to happen.

Also read | How to make your personal finance budget?

Accordingly, you can advance or postpone some expenses. Key would be always to spend only as much money as is left over after savings.

Prepare an emergency fund

This should include only essential spending and ideally be equal to six months’ worth of spending. This should be available in a savings bank account and your spouse/ dependents should also have access to the funds. If there is a critical/important milestone expense lined up during the year, it should ideally backed by certain investments, if not include that as well.

Take adequate life insurance cover

Based on annual expenses (essential + discretionary) as well as milestone costs, compute the amount of money required to maintain your current lifestyle. Term cover should ideally be the gross value of such expenses after factoring in inflation. If there are additional earning members in the family, the cover can be shared with them.

Reassess medical cover and plug the gap

One should assess each and every family member’s physical health, especially based on recent developments (COVID-19 and other health factors). Cost of treatment should be the benchmark for the medical cover. Based on this, recalibrate existing medical cover periodically so as to factor in inflation too. Explore alternative options like super top-up, critical illness policy, personal accident cover an so on to maximise benefits and/or optimize the premium amount. Review floater vs. individual premium plan premiums during every renewal.

Strive to invest 30% of income

The average savings rate in India is ~30 percent. This should be seen in the light of annual average per capita income being only Rs 1.5 lakh. So every earning member of the family should strive to save at least 30 percent of his/her income if not more. One should ensure that this ratio is maintained throughout his/her working life.

Activate monthly 80C investments

People tend to make tax-saving investments only close to the financial year-end. Investments in the Public Provident Fund (PPPF) and Equity-Linked Saving Schemes (ELSS), can be done on a monthly basis, which would actually maximise returns (power of compounding as well as averaging).

Also read | Here are some lesser known deductions to axe your income tax

This would not only reduce your financial burden on the year-end, but also instill a disciplined approach in you.

Ensure loans are backed by assets

As far as possible, if a loan has to be taken, an individual should ensure that it is for the purchase of an asset like a home or for future benefit, like education. These loans also provide tax breaks. Also, In a worst-case scenario, one can sell the underlying asset and repay the loan; this will not a significant impact on an individual’s net worth.

Also read | Are you ready to take a home loan? Check these 4 points

Try to repay debt

Corporate entities are in the process of reducing debt in these tough times. Individuals too should attempt to repay loans, especially high-cost ones like personal loans. This would not only improve their networth, but also help boost investments.

Endeavour to improve credit score to 750

Individuals having a score of 750 or more get the best credit terms. One can achieve a good credit score by paying EMIs, credit card bills and other loans before their due date. A lower score means not only higher interest rates but sometimes denial of loans too.

Pledge to maintain zero credit card debt

If one pays only the minimum amount due on a credit card, the balance costs 2.5 percent/month or more in interest. This more often than not puts a severe strain on finances and is the first step towards getting into a debt trap. In addition, the credit limit also tends to get truncated, which could lead to a financial squeeze in emergencies.

Make sure investments are tax-efficient

Interest earned on fixed deposits are added to an individual’s income and taxed in line with the person’s tax bracket. Investing in debt mutual funds provides an indexation benefit if held beyond three years and hence is more tax-efficient. Similarly, dividend earned by equity MFs are not taxed, but if an investor gets it from direct equity investments, tax is deducted at source. Also, instruments like PPF and Unit-Linked Insurance Plans (ULIPs) have exempt-exempt-exempt status while the National Pension System, National Savings Certificate and ELSS have exempt-exempt-taxable status.

Communicate financial details to family

Having done all this, it would be a disservice to the family if the details are not communicated to them. One should spell out details about bank accounts, insurance, investments and so on at least to the spouse. Recent reports say financial institutions have ~ Rs 1 lakh crore of unclaimed money. So an individual should ensure at least that all financial and immovable assets have a nominee. Ideally one should execute a will so the transition is smooth. Under Indian laws, a nominee is only a custodian.
Shankar K has two decades of experience in equity research. Views are personal.
Amitabh Tiwari is a former corporate and investment banker-turned political strategist and commentator. Twitter: @politicalbaaba.
first published: Dec 28, 2021 09:52 am
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