7 things to remember if you want to be financially free

Aug 14, 2017 10:32 PM IST | On Independence Day, here’s an attempt to show you what you would require to be more financially secure.

Moneycontrol News

On Independence Day, here’s an attempt to show you what you would require to be more financially secure.

1. Net worth It is the difference in value of all your assets (provident fund, small savings, house, mutual funds, gold, cash) and your debt (home loan, car loan, credit card debt). In an ideal situation, the total value of your assets should exceed your debt levels. It should also be rising as you grow older.It is important to calculate the net worth every year to give you a reality check of how your assets and liabilities stack up.

2. Financial goals Any of life’s big milestones that will require money—buying a car, vacationing, children’s education and children’s weddings, retirement—is a financial goal. It is important to list out these goals, which will vary according to each individual. For instance, you may have a goal of buying a house three years from now. Planning to achieve this goal would mean setting aside money to make the down payment for a house that you intend to buy.Please remember that "goals" are realistic targets you set based on your current and expected income stream. Don’t confuse these with “dreams,” which can push you into a world of make-believe.

3. Protection What happens to your family if you die and their income suddenly stops? It is absolutely critical to protect your family against your death by buying a life insurance policy.It will prevent the family from slipping into financial distress in the sad event of death of the principal breadwinner. Never forget to ensure that your insurance policy has a nominee and an assignee.It is also important to buy a health insurance cover. Remember, health care costs are rising rapidly and a simple procedure in a private hospital can now cost up to Rs 2 lakh.

4. Spending Plan What you don’t spend, you save. And vice versa. The spending-savings ratio often determines whether an individual is financially secure or not. There are three kinds of spending (a) routine, such as spending on household provisions, school fees, conveyance etc. (b) periodic, such as buying clothes, shoes, accessories such as mobiles and also occasionally eating out (c) planned, such as vacationing and charity; and (d) unforeseen, such as hospitalisation costs.

Health insurance can take care of hospitalisation costs, a regular income flow addresses routine and periodic costs. It is usually the third category of spending such as vacationing that needs to financial planning. It is advisable to plan your holidays much in advance and start setting aside money to fund these trips, lest you end up paying from your credit card at very high interest rates.

5. Wealth

It is important to distinguish between wealth and income. Wealth is what a person owns, income is what he/she earns. Income creates wealth over a period of time, but only if properly planned and managed. A big income flow does not necessarily lead to wealth creation.Income is earned in the present, while wealth can be created by spending income on things or assets that can generate additional income. Over time, these accumulated assets can reach values that will be sufficient for you to maintain a certain standard of living.Most importantly, wealth creation is necessary to deal with inflation, which erodes your real income. The two key rules of creating wealth: (a) start saving as early as possible with whatever little amount you can and (b) believe in the power of compounding.

6. Contain debt Everyone is familiar with stories about how families fall into debt traps because of multiple loans. Maintain a constant schedule of loan repayments and your current liabilities and avoid loans to repay existing loans.Experts say that no more than 40 percent of your net income should go towards servicing all your loans (home, car, credit card). Avoid delayed payments on credit cards. It will only add to your debt.

7. Will Don’t shy away from writing a Will. This would ensure that your kin doesn’t end up fighting over your wealth and assets such as property. A Will must be registered before a sub-registrar to ensure its legality. It has to be signed in the presence of two competent witnesses who are above 18 and are of "sound mind".Make sure that the Will’s witnesses and the executor are younger than you, which will give them a lower probability of dying before you. Besides, the assignees/nominees of your investments should be the same as the Will’s beneficiaries.