“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it” - Albert Einstein
We often procrastinate when it comes to managing money. It’s often because our society has made it overly complicated. Unless you’re an avid speculator, technical analyst, or gambler, for most of us financial planning does not have to be this hard. Anyone can grow their wealth and become wealthy provided they control their irrational urges and stick to a plan.
In this article, I am going to break down financial planning into 6 steps which if followed will transform your life and bring prosperity to your family. The end goal of this guide is not only to make you wealthy but to also enable you to live your life to its fullest.
1. Starter emergency fund
Save up to $1,000 (depending on your region/cost of living it can be adjusted. E.g. in India someone can save up ₹50,000). You don’t go on a long hike without carrying band-aids if not a first-aid box. This fund will take care of a lot of unexpected life events. It’s especially important for people who are trying to climb out of a debt of mountain. This ensures you don’t dig deeper holes while getting out of one.
2. Pay of debt
While a lot of smart and savvy investors talk about growing rich using debt, for an average Joe this is a bane rather than a boon. List down all your debts - credit cards, education, personal, etc. (except mortgage - home loan).
Aggressively start paying them in advance. Mathematically paying the one with the highest interest will save you more money but if there are multiple smaller ones and knocking them off makes you happy, feel free to do so.
Life is much simpler when you don’t have to worry about paying a monthly ransom. This is the first step towards owning your own life.
3. Fully funded emergency fund
Save up 3-6 months’ worth of your monthly salary and put it in a high-yield account. This is in case you lose your job. This buys you much-needed time without jeopardizing your life during crunch time.
4. Protect your family
Buy two insurances, which will give you a solid safety nest and peace of mind.
-
Term InsuranceA simple term insurance covering 15-20 times your annual salary. While adding a permanent disability rider might be a wise decision, don’t add unnecessarily complicated riders, especially the ones that promise to give guaranteed returns! (insurance and investment should be done separately). While money can’t replace the loss of a loved one, it can help them tide over a financial crisis. -
Health InsuranceBuy this even if your employer provides it. Cover all your family members (sometimes buying family floater plans can be better). Ensure it covers a wide range of treatments, doesn’t have a cap on procedures, or hospital rooms, and has a cashless facility with a large number of hospitals around you.
Do not forget to pay premiums promptly. Do not hide and falsify any information which would later make the claim procedure cumbersome during an already excruciating time for your family. Add/update nominees appropriately and share a copy with them providing all the details. Keep your health insurance cashless card with you always, you don’t want to miss out on availing cashless benefits by misplacing or forgetting your card.
5. Invest
Congratulations, by now you have cleared all your debts and have a decent safety nest for various uncertainties of life. Now that you have this solid foundation, it’s time to sow seeds of wealth.
Assuming the only debt is a home loan (say ~ 30% of your monthly income) and ~ 40% as other living expenses, you might have a bandwidth of ~ 30% for investment. If this is not the case, give serious thought to ways to increase your salary (change job, pick up a skill that pays more, cut down on unwanted costs).
Invest your money in the following way
- Start a monthly SIP in an
Index fund(don’t hassle too much about picking a mutual fund that your broker or friend is suggesting). Index funds not only have low management fees but also have odds of performing better than the expensive funds managed by experts. If you don’t believe me, check what Warrent Buffet has to say about it. - Make use of government-provided tax savings or high-yield accounts.
- Diversify (include gold/silver/REIT)
- Also put aside a certain amount in a retirement account.
Now the question most people have here is what should be my allocation in different asset classes. To answer this you should know what is the goal of the investment and the timeline for it. While equity gives higher returns it also has higher risks involved with it. So strike a good balance between debt v/s equity ratio (considering your comfort and risk appetite).
| Goal term | Debt Fund Allocation | Equity Fund Allocation | Example |
|---|---|---|---|
| Under 1 year | ~100% | ~0% | A vacation trip next year |
| 1~3 years | ~80% | ~20% | Buying a car |
| 3~5 years | ~60% | ~40% | Down-payment for a house |
| 5~7 years | ~40% | ~60% | Univerity fees for child |
| Above 7 years | ~20% | ~80% | Retirement |
6. Pay off your house debt
Once you have a systematic investment plan set up, ensure it’s never below 20% of your monthly income. In other words, you must save at least 20% of your salary. If you can manage this without any additional burden on your lifestyle and still have extra cash, then it’s time to tackle the home loan.
Some might say this can take a long time, but it’s not quite impossible either. For a good average productive person, their income should grow faster than their lifestyle cost and there will always be chances where that extra money can be put to good use. The idea is to take off your burden and make you financially free. You want to be happy doing this and not miserable.
Giving back
Congratulations, you have elevated yourself from the masses and put yourself in a place where you have the freedom to carve out your path, explore uncharted courses, and experiment with your life more than you could ever before. At this stage, I want you to reflect on how you could help make this world a better place, help others, and educate people on how they can achieve financial freedom.
Retirement
Retirement has a different meanings for different people. While some might see retirement as leaving the workplace at 65 and relaxing, others might see retirement as quitting their job in the ’30s and starting a second career. Whatever your goal, calculate how much returns your passive income should generate to sustain the life you desire.
In the end …
enjoy this whole process of getting wealthy. Don’t be cheap; spend money on things that you truly enjoy and that give you happiness, but cut costs on things that don’t matter much.
For me, the experiences I gain through traveling are priceless. So, rather than wasting money on fancy hotels or business class flights, I prefer to spend it on exploring new places and having new adventures. Use your money on things that are meaningful to you and will help you create memories for a lifetime!