Managing money both an art and a science

Jul 25 2014, 02:38 IST
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SummaryOne earns money through salary/enterprise/businessconsultancy or even from investments and inheritance.

One earns money through salary/enterprise/businessconsultancy or even from investments and inheritance. As cash flow increases, the real challenge is to manage the money.

The first and foremost step is to have clarity on various financial goals. One can look at the tried-and-tested bucket method of investing, where one earmarks money for fees, birthdays, festivals, etc. Today, it is known as goal-based investing, which involves asset allocation and time horizon. If you look closely, the bucket method is all about goal-based investing. Keeping it simple and easy to understand and implement is the key.

Suppose, you need to plan for higher education of your child. To build a corpus of R10 lakh after 10 years considering 7% inflation and 12% return, one needs to save R8,650 per month. If you do not consider inflation, then you need to set aside only R4,300 a month.

If you inherit money, or get a big bonus, the approach should be to look at asset allocation for long-term wealth creation. Moreover, the inheritance corpus can also be used to retire high-cost debt like personal loan or credit card loan, if you have any. This would not only give you peace of mind, but also improve your cash flow and reduce monthly interest payments.

Why do we get it wrong?

So, one may ask: If managing money is so simple, why do people go wrong? It is because of behavioural biases that many investors have. Typically, we like to follow what the latest fad is. For example, as equity investments are generating high double-digit returns now, many are moving their investments to stocks. But keeping all eggs in one basket can be very dangerous for an individual investor. Secondly, we also like to invest in what our friends and relatives have gone for — the herd mentality — without realising that your investing goals may not be similar to others. Here, failing collectively is acceptable rather than winning individually.

Third, asset-class bias is a common observation. Maybe, your early investments in a particular asset class have delivered returns for you. Mentally, you are prone to invest in that particular asset class time and again.

Investing in products that were traditionally preferred by parents and grandparents still continue to attract most of us. As you are familiar with the product, you want to take the easy approach.

But that may not be the optimum approach. For instance, in the last

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