The Multiple Skills Involved in Personal Finance
Co-authored by Smriti Bansal
We all have heard many crazy rags to riches stories about how people become millionaires or billionaires almost overnight. Often, we read them to find out the secret to such amazing wealth and success. But rarely are we able to discover the real reason for such success and wealth. In reality, such fantastical stories are pretty useless. What we need are simple personal finance skills to live a financially fulfilling life.
Some very basic personal finance skills can become the stepping stones to a comfortable future with minimal or no financial setbacks.
The sad truth is that we don’t give enough importance to personal finance skills in formal education. Another challenge is that people around us who actually possess personal finance skills rarely share their secrets.
At Lokyatha, we believe that the knowledge related to personal finance should be easily available to everyone. We need to focus on the foundational financial literacy skills which can accelerate our financial journey.
Let us learn about the three basic personal finance skills.
- Earning money,
- Budgeting and saving money, and
- Investing the money saved
Skill 1: Earning money
Most financial guides do not give enough attention to this very important step. People assume that personal finance begins only after someone has money. They also assume that most individuals earn via a salary. Any other sources of income are categorized as ‘passive income’. This is unbalanced advice. It does not consider people who earn their primary income via freelancing, business, contractual work, and so on.
However, at Lokyatha we believe that earning income from any source is relevant especially in today’s age of the gig economy. (In a ‘gig economy,’ companies are more likely to hire people on a contract or freelance basis instead of on a full-time basis. This trend has been increasing in India as well.)
Earning money hence is the first step towards personal finances. And honestly, it is the really exciting part too! This is the part that allows us to explore our interests and to grow professionally.
In order to have any money to manage, we have to earn it in the first place.
So, one’s incomes could come from a job with a salary and/or commissions, real estate that earns rental income, or business or equity investments that pay dividends.
Blogging, writing an e-book, affiliate marketing, or freelancing are examples of other fruitful avenues for creating wealth through additional income sources. For our younger readers, earnings could also be pocket money, monthly allowances, or earnings from part-time jobs.
Understanding the importance of our primary income source
As we grow in our careers however, we have to identify our primary source of income. This source must be recurring and sustainable.
Identifying and maintaining our primary source of income is critical. This is what is called our ‘bread and butter’. This income should help us survive without depending on any other source. In some cases, people have to maintain more than one job just to manage their basic expenses. This is a harsh reality.
Being able to look forward to the future and predict our earning potential is important too. Maybe there’s a promotion lined up, or a plan to switch jobs to earn more. This is important to be able to predict upcoming changes in our income flows.
(We have a separate series coming up to help hone your professional skills. We expect that it will enable you to keep your primary source of income consistent, and hopefully grow it further.)
Alternate sources of income
People who have done well financially usually have multiple income sources. They also continue searching for newer avenues to increase their income. This is a terrific approach to building wealth in the long run.
Many financial gurus advocate for creating multiple income streams.
However, many young people with stars in their eyes, tend to go after ‘passive’ sources of income without having a stable primary source. This is a major problem. It often leads to financial ruin if one tries to do this too aggressively, too early on. Many online and small-scale Ponzi schemes have become extremely common these days because of this.
Skill 2: Budgeting and saving money
This step is probably the hardest part of building wealth. It includes being disciplined by maintaining a budget, keeping track of expenses, and saving. Depending on one’s preferred lifestyle and cultural views on spending money, it can seem pretty hard, or even impossible. Let us read about each sub-skill.
Keeping track of expenses: The forgotten skill of personal finance
The most ignored and near-forgotten principle of managing finances is how we spend our money. Our spending patterns can reveal a lot about us: our habits, priorities, and where we need to course-correct.
No matter how much we earn, our current earnings will never be enough if we don’t invest our time and energy to manage our money.
Generally, a good pay raise and increased business earnings also lead to a corresponding increase in expenses.
Every time we earn more, all our dreams come to the surface.
We start to consider buying that new phone, planning a trip, or finally buying a vehicle. We sometimes even plan such expenses on anticipated income. The result is that the extra cash soon disappears, creating zero impact on our net-worth.
Budgeting is the best tool for personal finance which can make us financially disciplined and track our expenses effectively. It is a guide that you create that tells you how to spend, how much to spend, and how much to save, etc.
Of course, resisting temptations and questioning ourselves each time before we buy anything is an important habit to cultivate if we want to budget and save. But ideally the order of things should be to identify our expenses first, so we can create a budget to plan our spending and saving.
Saving: The ancient wisdom of personal finance
Saving basically means setting aside money to fulfil one’s financial goals. Many of us tend to leave saving for the end – after all the spending is done. We hope to save whatever is left. But this rarely happens. Even if it does, it is not systematic or organized and doesn’t give the best results.
The best way to ensure we can save is to set a savings target within one’s budget. This needs to be done before we spend.
Maintaining savings in bank accounts through fixed or recurring deposits has been a common and effective way for Indians to park their surplus money. It has been acting as the much-needed emergency fund or backup for major life events for many Indians. Banks and financial institutions such as the post office, have also been the traditional hot-spots for saving money in India.
The significant place of saving in Indian hearts can be attributed to the ideas of protecting capital and compound interest. In fact, this simple principle of mathematics is the reason behind the everlasting love affair of Indians with conventional options for investing such as PPF (Public provident Fund), FD (Fixed Deposit), RD (Recurring Deposit), and so on.
In the words of Albert Einstein: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
We need to develop the habit of saving like older generations to weather all kinds of storms in life. It might be surprising to know that household savings as a proportion of the GDP have declined to 18.2 per cent in 2019 compared to 19.6 per cent in 2015, and 22.4 per cent in 2008. This is a worrying trend and needs to be reversed.
Skill 3: Investing: The fruit-bearing tree of personal finance
“Someone's sitting in the shade today because someone planted a tree a long time ago.” - Warren Buffet
The above quote by one of the world’s greatest investors reflects the importance of investment. Investing money is like sowing seeds to reap fruits later. It can look similar to saving. However, both the risk and return in investment are higher. And it can effectively take care of our larger and long-term goals.
Many people think that investing is just trading in stocks and commodities. However, in reality, we need not deal in stocks or the market for investing.
Investing in stocks requires a substantial amount of knowledge and expertise that can be developed over time.
There are simpler investing tools nowadays like mutual funds, Unit Linked Insurance Plans (ULIPs), Equity Linked Savings Schemes (ELSS), etc. These are easier to use for people who are not experts.
Real estate is also a valuable investment option because of its potential to give high returns. But it mostly remains under-explored because of the huge capital requirements. With the growing popularity of Real Estate Investment Trusts (REITs) in India, investment in real estate is becoming more accessible.
(More on REITs in our other upcoming articles.)
We should avoid thinking that we will work on our personal finance only after we begin to earn more money. Remember, earning more is definitely something we can strive for; but that is just one of the skills of personal finance. To put this in context, the NBA basketball player Shaquille O'Neal spent the entire $1 million earnings from his first contract in less than 60 minutes.
Personal finance skills begin from where we are today.
Whether one earns 2 lac or 20 thousand a month, we can start on the path to achieving financial freedom early in life. If we are unable to manage our finances and lifestyle with 20 thousand a month, it is unlikely we will be able to do so with 2 lac either. Learning these personal finance skills is essential. The most optimal way to create financial stability is to begin now.
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Disclaimer: This article is for educational purposes only. It should not be considered financial or legal advice. Please consult a financial professional before making any significant financial decisions.