101: How to not lose your money

You are earning a good salary and have more than enough for your needs. The remaining money is sitting in your savings bank account. You think that you are saving enough money, so life is good. You plan to use the savings to fulfill your dreams in the future. But you’ve got it wrong, you are losing your money.

Let’s do the calculation:

You have INR 1,000 in your Savings Bank Account. The bank gives you 4% interest. So after 1 year, you will have INR 1,040 in your bank account. But wait — the inflation rate for the year is 5% which means if something was selling at INR 1,000 last year, it will cost INR 1,050 this year. That means you could afford it last year but you can’t this year. India’s inflation rate was 4.76% in 2019. This is higher than the savings bank account interest rate offered by India’s major banks such as SBI, ICICI, and HDFC (3%-4%).

I am a Software Engineer based in India. I don’t have any background in finance. I took a course in finance during my undergrad but barely passed it. But it doesn’t matter because you don’t need any background in finance to learn personal finance. In the next 20 minutes, I am going to summarize everything I’ve learned about personal finance. Before I begin, here is a disclaimer:

Views expressed in this post are my own and do not represent those of people, institutions, or organizations that I may or may not be associated with, in a professional or personal capacity.

In 2019, I landed my first job. At the time I didn’t know much about personal finance. What I did know was that getting your first paycheck is an awesome feeling, and after getting my first paycheck, I spent some of it and invested some of it in PPF to save on taxes. Saving on taxes is the first thing one can do after getting their salary. It’s not illegal to save on taxes, and there are a few sections in the Income Tax Act that allow you to save a few thousand rupees through deductions and exemptions.

Saving on Taxes

Tax Deductions and Tax Exemptions help you reduce your taxable income which ends up helping you save on taxes.

Tax deductions simply help you reduce the taxable income by making some investments and/or getting an insurance plan. The following are the tax deductions available according to the Income Tax Act:

• Investment under section 80C instruments like Public Provident Funds(PPF), Employee Provident Fund(EPF), Equity Linked Savings Scheme(ELSS), National Pension Scheme(NPS), Unit Linked Investment Plan(ULIP). Premium paid for a term insurance plan also comes under Section 80C. You can claim a maximum deduction of INR 1.50 lacs under this section. I will talk about each investment instrument under this section later in the series.

• Under section 80D, Premium paid for health insurance for you, spouse, and dependent children you can claim a deduction of INR 25,000. An extra INR 25,000 claim if you pay a premium for your parents under age 60 or INR 50,000 if parents age above 60. You can also claim an extra INR 5,000 on the health checkup of family members.

• Under section 80E, Interest paid on an education loan for yourself, spouse or children can be claimed. There is no upper limit on the amount. Under section 80EE, first-time homebuyers can claim interest on a home loan up to INR 50,000.

Tax exemptions reduce your taxable income through expenses such as house rent, transportation, and travel allowances. If you are a salaried individual, you should take a look at your payslip. You may receive a few components in your pay such as House Rent Allowance, Transportation Allowance, Leave Travel Allowance(LTA/LTC), Medical Reimbursement, and Food Coupons. All of them can be used to reduce your taxes if you have proofs for house rent, transportation, medical checkup, etc. If you want to take a deeper look at how these tax deductions and exemptions work, please read this post by Cleartax.

Note, however, that from FY 2020–21, the government introduced a new tax regime for income tax. Under the new regime, tax rates are slashed for a few income slabs, but you can’t claim any tax deductions and exemptions. So it’s best if you calculate your income tax under both regimes and pick the one that works the best for you. You can use this calculator by Cleartax.

Insurance

After getting paid, getting insurance is one of the best things you can do with your salary. Not only will it help you save on taxes, it will also help you and your loved ones when you are met with unfortunate events such as an accident, serious illness, or even death. There are two types of insurance that you must get —

Term Insurance

Life is unpredictable. If you are met with an unfortunate event such as death, term insurance protects your loved ones and family financially. When you opt for a term insurance plan, you choose a covered amount and a covered age. If you die before the covered age, your nominee (family) will receive the covered amount. Now let’s talk about how these term insurance plans work and how should you choose one.

For this to be easier to understand, let’s use an example. Ramesh purchased term insurance with INR 2 crores coverage insured up to age 65. This means if Ramesh dies before age 65, Ramesh’s nominee will receive INR 2 crores which are completely tax-free. Ramesh will pay an annual premium to the insurance company from the date of purchase to the year Ramesh turns 65 (if Ramesh lives till age 65). Now the question you might want to ask is: What will happen if Ramesh doesn’t die by age 65? Will he get any money after that? Well, the answer is NO. Ramesh will not receive any money if he doesn’t die within the insured age.

What’s the right age to buy term insurance?

Nice question. The answer is now. Buy it as soon as you can. I am 23 right now. If I purchase an INR 2 crores term insurance insured up to age 65, it will cost me around INR 17,000 per year until I turn 65. The total premium that I will pay is around INR 7,14,000. Now let’s imagine I was 33 years old, and for the same INR 2 crores coverage up to age 65, I will have to pay INR 28,000 per year until I turn 65. That’s a total premium of INR 8,96,000. That means I would have to pay a 25% extra premium if I started later. This is a huge difference, so the best time to buy term insurance is as soon as you can.

How to choose the covered amount, age, and insurer?

The covered amount ideally should be 15–20 times your annual income. The ideal insured age should be the age you have decided to retire on but you can get a higher age coverage — up to age 75/85 or even 95 years — but it will increase the premium amount significantly. A higher cover amount will also increase the premium amount.

To choose an insurer, you should look at the insurer’s claim settlement ratio (higher is better). You can compare various term insurance plans on Policybazaar.

The amount paid towards the term insurance annual premium can be claimed as a tax deduction under section 80C.

Pro-tip: Some insurance agents will suggest you buy term insurance with endowment or ULIP so that you will get some premium amount back if you don’t die within the insured age. Do not fall for it. It will increase the premium amount significantly or decrease the covered amount drastically for the same premium. You should try to maximize the cover amount. Also, always try to buy the policy online, it will save you up to 5% in premiums.

Health Insurance

This is the second insurance you must have. There’s a saying “You are one serious illness away from bankruptcy” and it’s true. Hospital bills can be really large. If you are a salaried individual, there are chances that your employer has already insured you. But if it’s not the case, you should buy health insurance. There are tons of health or medical insurance plans available and you should compare a few plans to find what suits you and your family. You can compare all the plans online on Policybazaar.

Now that you have these two insurance plans which will protect you and your family, it’s time to grow your money.

Don’t work for money; make it work for you. — Robert Kiyosaki

Making the money work for you

All the wealthy people in the world have one thing in common: They don’t work for money, money works for them. There are many ways to make money work for you.

1. Business — If you are savvy and business, this is one of the best ways to make money work for you. Most of the world’s richest people own a business. There are people buying your products, and there are people working for you to grow your business even while you are sleeping.

2. Passive Income — Finding a way to generate streams of passive income is also a very good way to make more money. Some examples are building a product/app that people buy, or making content that pays for views. You only need to create a product/content once and it will pay you for many years.

3. Assets — Having money-generating assets is also a great way to make money work for you. These assets include stocks, mutual funds, real estate, provident funds, etc. I’ll also discuss commodities like gold, silver, and oil here.

Since this post is on personal finance, I’ll only talk about money-generating assets.

Before I get to various money-generating assets, it’s important that I talk about some terms people use in finance, once you understand these terms, it will be easier for you to understand investing.

Some important terms

• Security — An asset that can be traded. Stocks, ETFs, mutual funds, bonds, gold, crypto, etc are called securities. These are also called instruments.

• Volatility — The degree of variation of the price of an asset. In simple terms, if I say this security has high volatility, it means the price of this security can increase or decrease by a high amount in a period of time. Usually, the higher the volatility, the riskier the security.

• Liquidity — How quickly and easily an asset or security can be converted into ready cash without affecting its market price. Higher is better.

• Portfolio — The collection of all your investments in stocks, mutual funds, ETFs, real estate, gold, crypto, or any other asset classes.

Great! Now you know enough that you won’t feel missed out when someone is talking about investing.

What is investing?

When you use your money to buy assets or securities in hope that they will generate income or profit for you, this is called investing. These assets or securities make money for you. So you can say that your money is working for you to make more money. The profit or income that you make on the invested amount is called return on investment (ROI) or simply returns.

Let’s take an example to calculate returns or ROI:

I bought 100 shares of a company at INR 500 each, after 5 years when the price of the shares appreciated and reached INR 1200 each, I sold all the shares. I invested INR 50,000. After 5 years I sold the shares for INR 1,20,000. This is a profit of INR 70,000. If I calculate ROI, it’s 140% (or 19.14% annualized ROI). This means If I get 19.14% returns every year on my investment, after 5 years the current value will become 2.4 times what I invested.

Certain investment schemes like PPF, EPF, NPS, etc give compound interest. In that case, the compound interest rate will be the annualized ROI. For example, the interest rate of PPF for this financial year is 7.1%. This means annualized ROI for PPF will be 7.1%.

When you invest in stocks, mutual funds, ETFs, gold, crypto, or any other asset, you can calculate annualized ROI using an online calculator.

Start investing as early as possible

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. — Albert Einstein

I am going to explain the magic of compound interest (annualized ROI) through an example.

Example: If you invest INR 10,000 every month for 10 years and get annualized ROI (compound interest) of 10%. The total amount you invested is INR 12,00,000, but the current value of the invested amount is INR 20,65,520. You earned INR 8,65,520 in returns (interest). You continue to invest the same INR 10,000 every month for 5 more years. Now the invested amount is INR 18,00,000 but the current value is INR 41,79,243. You have earned INR 23,79,243 in returns (interest) which is more than the invested amount. Again, you continue to invest INR 10,000 per month for the next 5 more years. Now the invested amount is INR 24,00,000 but the current value is a whopping INR 76,56,969. You earned INR 52,56,969 in returns (interest) which is more than double the invested amount.

Time is money. — Benjamin Franklin.

I hope now you understand why you should start investing as early as possible.

In the next part of this series, I discuss various investment assets you can use to invest your money.