Financial Literacy, Financial Planning and Budgeting

Importance of Financial Education/ Literacy Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. “Financial education enables individuals to improve their understanding of financial concepts and products, prevent fraud, make decisions appropriate to their circumstances and needs, and avoid undesirable situations arising either from excessive indebtedness or unsuited risk positions.” • • • • • The term “financial literacy” refers to a variety of important financial skills and concepts. People who are financially literate are generally less vulnerable to financial fraud. A strong foundation of financial literacy can help support various life goals, such as saving for education or retirement, using debt responsibly, and running a business. Key aspects to financial literacy include knowing how to create a budget, plan for retirement, manage debt, and track personal spending. Financial literacy can be obtained through reading books, listening to podcasts, subscribing to financial content, or talking to a financial professional. Understanding Financial Literacy financial products and services have become increasingly widespread throughout society. Given the importance of finance in modern society, lacking financial literacy can be very damaging to an individual’s long-term financial success. Being financially illiterate can lead to a number of pitfalls, such as being more likely to accumulate unsustainable debt burdens, either through poor spending decisions or a lack of long-term preparation. This, in turn, can lead to poor credit, bankruptcy, housing foreclosure, and other negative consequences. Financial literacy can help protect individuals from becoming victims of financial fraud, a type of crime that is becoming more commonplace.4 Scope of Financial Literacy Although many skills might fall under the umbrella of financial literacy, popular examples include household budgeting, learning how to manage and pay off debts, and evaluating the tradeoffs between different credit and investment products. These skills often require at least a working knowledge of key financial concepts, such as compound interest and the time value of money. Other products, such as mortgages, student loans, health insurance, and self-directed investment accounts, have also grown in importance. This has made it even more imperative for individuals to understand how to use them responsibly. Financial literacy can cover short-term financial strategy as well as long-term financial strategy, and which strategy you take will depend on several factors, such as your age, time horizon, and risk tolerance. Financial literacy encompasses knowing how investment decisions made today will impact your tax liabilities in the future. This also includes knowing which investment vehicles are best to use when saving, whether for a financial goal like buying a home or for retirement. This is not to add the novelties in finance such as e-wallets, digital money, buy now/pay later, P2P lending, and other new financial products that can be convenient and cost-effective but require potential consumers to be educated to assess them adequately to their advantage. Importance of Financial Literacy/Education Holistically, the benefit of financial literacy is to empower individuals to make smarter decisions. More specifically, financial literacy is important for a number of reasons. • • • • • • Financial literacy can prevent devastating mistakes: Floating rate loans may have different interest rates each month, while traditional individual retirement account (IRA) contributions can’t be withdrawn until retirement. Seemingly innocent financial decisions may have long-term implications that cost individuals money or impact life plans. Financial literacy helps individuals avoid making mistakes with their personal finances. Financial literacy prepares people for emergencies: Financial literacy topics such as saving or emergency preparedness get individuals ready for the uncertain. Though losing a job or having a major unexpected expense are always financially impactful, an individual can cushion the blow by implementing their financial literacy in advance by being ready for emergencies. Financial literacy can help individuals reach their goals: By better understanding how to budget and save money, individuals can create plans that set expectations, hold them accountable to their finances, and set a course for achieving seemingly unachievable goals. Though someone may not be able to afford a dream today, they can always make a plan to better increase their odds of making it happen. Financial literacy invokes confidence: Imagine making a life-changing decision without all the information you need to make the best decision. By being armed with the appropriate knowledge about finances, individuals can approach major life choices with greater confidence realizing that they are less likely to be surprised or negatively impacted by unforeseen outcomes. Making a budget: If you want to understand money management, the first thing you need to do is make a budget. It is of supreme importance to critically monitor how much you are earning and where it is getting spent. There are many software applications available to make this job a piece of cake. Emergency fund: A financially educated person understands the importance of an emergency fund. The current scenario, more than ever, has made us realize that at any point in life we must have three to four months of expense set aside as savings. It is a decisive way to avoid debt. Covid-19 pandemic has not only endangered millions of lives around the globe but has also plunged many people into a financial crisis. One of the many critical lessons that the coronavirus has taught us is the importance of being financially prepared. Financial education is a basic life skill that has a direct impact on personal well-being. Basics like money management, savings, investing and debt will lay a strong foundation for money habits if imparted from a young age. Learning personal finances and important money skills at an early age provides with lots of opportunities to apply them in real life. If you are already in a habit of budgeting, saving regularly and spending wisely, think about the jump-start you get in life. People who understand how money works can start earning and investing from an early age and avoid lifelong money struggles. Strategies to Improve Financial Literacy Skills Developing financial literacy to improve your personal finances involves learning and practicing a variety of skills related to budgeting, managing, and paying off debts, and understanding credit and investment products. The good news is that, no matter where you are in life and financially, it’s never too late to start practicing good financial habits. Here are several practical strategies to consider. Create a Budget Track how much money you receive each month against how much you spend on an Excel sheet, on paper, or with a budgeting app. Your budget should include income (paychecks, investments, alimony), fixed expenses (rent/mortgage payments, utilities, loan payments), discretionary spending (nonessentials such as eating out, shopping, and travel), and savings. Pay Yourself First To build savings, this reverse budgeting strategy involves choosing a savings goal, such as paying for higher education, deciding how much you want to contribute toward it each month, and setting that amount aside before you divvy up the rest of your expenses. Pay Bills Promptly Stay on top of monthly bills, making sure that payments consistently arrive on time. Consider taking advantage of automatic debits from a checking account or bill-pay apps and sign up for payment reminders (by email, phone, or text). Get Your Credit Report Once a year, consumers can request a free credit report from the three major credit bureaus— Equifax, Experian, and TransUnion—through the federally created website AnnualCreditReport.com.7 Review these reports and dispute any errors by informing the credit bureau of inaccuracies. Because you can get three of them, consider spacing out your requests throughout the year to monitor yourself regularly. In a 2021 survey by the Federal Reserve, 22% of adults in the United States reported not being OK financially and not living comfortably financially.8 Check Your Credit Score Having a good credit score helps you obtain the best interest rates on loans and credit cards, among other benefits. Monitor your score via a free credit monitoring service (or, if you can afford to and want to add an extra layer of protection for your information, use one of the best credit monitoring services). In addition, be aware of the financial decisions that can raise or lower your scores, such as credit inquiries and credit utilization ratios. Manage Debt Use your budget to stay on top of debt by reducing spending and increasing repayment. Develop a debt reduction plan, such as paying down the loan with the highest interest rate first. If your debt is excessive, contact lenders to renegotiate repayment, consolidate loans, or find a debt counseling program. Invest in Your Future If your employer offers a 401(k) retirement savings account, be sure to sign up and contribute the maximum to receive the employer match. Consider opening an individual retirement account (IRA) and creating a diversified investment portfolio of stocks, fixed income, and commodities. If necessary, seek financial advice from professional advisors to help you determine how much money you will need to retire comfortably and develop strategies to reach your goal. FINANCIAL PLANNING PROCESS The correct investment strategy and sound financial advice will determine how you live today and in the future. There are six stages to develop a financial plan and to carry out personal money management. From beginning to end, a certified financial planner professional guides you through the financial planning process - keeping in view your current financial situation and economic background. Financial planning is a dynamic on-going process that requires continuous monitoring. Review of the actions recommended in the plan should take place regularly, and the goals should be reviewed annually to take account of a change in income, asset values, business or family circumstances. Financial Planning that follows a properly defined and documented process will give the greatest chance of a successful outcome. It will not guarantee financial security or wealth but will provide an opportunity to pursue both and requires proper analysis, discipline and expertise. The financial planning process is evaluating your net worth and risk profile, setting short to long-term financial goals, and revising your goals over time, if necessary. It also involves strategies on how to retire without having to worry about finances and securing your family’s future. 1) Identify your Financial Situation The first stage of the financial planning process constitutes assessment on what is happening in your life right now and how you can change your financial situation. The key areas to reflect are: Household budgeting –This is an important area as after calculating the monthly costs spent at home, you’d be able to figure out how much you are left with to save or invest. Family commitments and Living Expenses – Are you single or married? Do you have children? What are their living and lifestyle expenses? Tax Standing and Strategies – How do you manage taxes? Are you living or working abroad? Current investments or saving reserves – How much savings or debts you have right now? Other Financial obligations – These may involve some miscellaneous costs you might be planning ahead for future such as: • • • • A wedding or property purchase Emergency funds to cover for household catastrophes Family Funds reserve in case something happens with your job or you Is your retirement just around the corner? Step 1 – Gathering your financial and personal information The financial planning process and its success will depend on the quality and clarity of the information communicated to your adviser. Your adviser will complete a detailed financial fact-find to capture all relevant information in relation to your finances. This will include: • • • Income and expenditure Assets and liabilities Risk attitude, tolerance and capacity This step serves as a foundation for developing your plan and gives you a good reference point to achieve your short as well as long term financial goals. 2) Determine Financial Goals Experts say when you have identified your goals; you’re most likely to achieve them. Highlighting the financial goals serves as an important aspect of financial planning. Subjected to what phase in life you have reached, these goals could be: • • • • • Get married and initiate Purchase or pay off Ensure your children get a Make your reserves and investments Get retirement with enough income on hands to enjoy life ahead a a good tax family property education proficient The sole purpose of this step is to differentiate your needs from your wants. Apart from these, the goals or objectives may range from spending your entire income into developing a long lasting investment program for future financial security. However, you must select which goals you need to pursue. Step 2 - Defining and agreeing your financial objectives and goals The goals and objectives will be the guide to the financial plan and should provide a roadmap for your financial future. They should contain the following features: • Quantifiable and achievable • Clear and have a defined timeframe • Separate your needs from your wants They should be agreed and documented with your financial adviser to assist you measure progress. They should also be reviewed periodically to capture changing circumstances and to ensure they remain relevant. Step 3 – Analysing your financial and personal information Your financial adviser reviews the information provided in step 2 and uses it to produce a report that reflects your current financial profile. The following ratios are produced to improve your understanding of your financial circumstances and to pinpoint areas of strength or weakness: • Solvency Ratio • Savings Ratio • Liquidity Ratio • Debt Service Ratio Your attitude, tolerance and capacity for risk are assessed using a psychometrically designed risk tolerance questionnaire in relation to investment assets. This is also analysed to assess your asset allocation for investment or pension goals. 4) Identify Alternatives for Investment After a thorough understanding of your financial needs has been taken and all the appropriate financial goals have been cemented down, next thing is the investment alternatives or specific recommendations from your financial planner. By taking a good look at your short, medium and long term goals, an integrated investment strategy would be developed based on your set requirements. Furthermore the objectives would be looked upon again and it will be analyzed how far you are down the road to achieving your short and long term financial goals. Taking in account your timeframe, cash flow, risk tolerance, current insurance coverage, tax strategies and investment goals, a range of ideas and financial planning alternatives would be presented in order to determine which one suits you the best. This will help you produce more actual and satisfying decisions. 5) Evaluate Alternatives The proposed recommendations are then further assessed. This is your chance to discuss the alternatives face-to-face and take necessary actions bearing in mind your current situation, financial standings and personal interests. If you have any concerns regarding your financial planner’s recommendations, those can be altered and revised. Alternatives can be closed down based on the decisions you make. For instance: The idea to carry on your education attests you cannot do a full time job. Decision making thus stands as an ongoing process which works side by side with your personal and financial situation so lost opportunities as a result of your decision making should always be kept in mind while analyzing the alternatives. Risk Evaluation While evaluating the options you might end up having uncertain ideas. For instance, choosing your career over studies involves risk. How can you ensure if it’s rewarding in your future? Other financial decisions involve a comparatively low degree of risk such as saving your money in a savings account or purchasing some object of great value with it. The option of losing that object is low in such scenarios. Thus while making financial decisions; finding out risks and evaluating them is tricky. You need to collect data based on your experience and the experiences of others as well. Decisionmaking process will require you to frequently update your knowledge politically, economically and socially so you can make informed decisions. 6) Put Together a Financial Plan and Implement Once you are content with the recommendations and feel good to proceed, the implementation of the plan would be carried out. This step of financial planning process can be considered as an action plan where you will pick ways to achieve your short, immediate or long term goals. Often taken as the toughest step for some people, but makes a huge difference in the long run! The key thing to consider here is to carry it out as early as you can. The longer it’s left unattended, the longer it will take you to grow your wealth – ultimately a great shortfall in your savings when you retire. Step 6 – Development and presentation of the financial plan The financial plan is developed based on the information received in step 2 and analysis completed in step 3. Each of the goals and objectives in step 1 should be addressed and a recommendation for each identified. It will include: Net worth statement (a balance sheet) Annual consolidated tax calculation Annual cash flow report (displaying surplus or deficit) The report is presented, explained, discussed and then signed by both client and adviser. • • • 7) Review, Re-evaluate and Monitor The Plan Financial planning is an on-going and dynamic process and it’s unlikely that your financial condition will remain same throughout your life. You need to assess your financial decisions periodically as changed personal, economic and social factors will require you to alter your decisions to fit into your new situation. As you progress through the different phases of your life, you financial needs will be reflected and financial process will serve as a tool to let you adjust to these changes. Monitoring your plans will help you prioritize your decisions and make necessary adjustments that will bring your financial needs and goals in line with your current life situation. Step 7 – Implementation and review of the financial plan Once the analysis and development of the plan is complete, the adviser will outline the recommended courses of action. This can involve implementing: • • • • A new pension or investment strategy Changing debt provider Additional life or serious illness insurance Income and expenditure adjustments Risk and Return Definition The concept of risk and return makes reference to the possible economic loss or gain from investing in securities. A gain made by an investor is referred to as a return on their investment. Conversely, the risk signifies the chance or odds that the investor is going to lose money. In the case that an investor chooses to invest in an asset with minimal risk, the possible return then is often modest. In contrast, an investment with a high-risk component has a higher probability of generating larger profits. A risk is the chance or odds that an investor is going to lose money. A gain made by an investor is referred to as a return on their investment. The amount of risk that individuals accept is measured by the amount of money they can potentially lose on their initial investment. The likelihood of a loss, as well as the amount of that loss, are both examples of risk. When someone refers to a certain investment as "highrisk," they may suggest that there's a considerable possibility that money will be lost or even a small possibility that all the money someone has could be lost. The quantity of funds you anticipate gaining back from an investment above the amount you first put in is referred to as the return. If an investment earns even a red cent more than your original investment, it has produced a return. But if expressed in negative figures, a return may also reflect a quantity of money lost. In any case, returns are often displayed as a percentage of the initial investment. When an investment works effectively, risk and return ought to be highly correlated. The larger the risk of an investment, the higher the possible reward. An extremely safe (low-risk) investment, on the other hand, should typically provide smaller returns. Types of Risks Whenever you invest or save, there are different types of risks that can be involved. But there are typically two categories that the risks are placed into: systematic risks and unsystematic risks. Systematic Risks that can influence a complete economic market or at minimum a significant portion of it are known as systematic risks. They are the dangers of losing assets as a result of various macroeconomic or political risks which impact the general market performance. There are many types of systematic risks; a few of those are: • Political risk - Political risk arises largely as a result of political insecurity in a nation or area. For example, if a country goes to war, the firms that operate there are deemed unsafe, and therefore risky. • Market risk - Market risk is the byproduct of investors' overall inclination to follow the market. So it is essentially the inclination of security values to shift together. • Exchange rate risk - This type of risk arises from the unpredictability of currency value fluctuations. As a result, it impacts enterprises that conduct foreign exchange operations, such as export and import firms, or firms that do business in a foreign country. • Interest rate risk - A shift in the market's rate of interest causes this type of risk. It mostly affects fixed-income assets since bond costs are connected to interest rates, but it also affects the valuation of stocks. Risks that can influence a complete economic market or at minimum a significant portion of it are known as systematic risks. Unsystematic Unsystematic risk is a type of risk that impacts only one sector or one business. It is the danger of losing money on an investment because of a business or sector-specific hazard. A shift in leadership, a safety recall on a good, a legislative reform that might reduce firm sales, or a new rival in the market are all examples of unsystematic risk. Unsystematic risk is the danger of losing money on an investment because of a business or sector-specific hazard. Systematic vs Unsystematic In order to help you better understand, let's review a few of the main differences between systematic and unsystematic risks: • • • Return Systematic risks can't be controlled but unsystematic risks can be controlled. Systematic risks are caused by external factors while unsystematic risks are caused by internal factors. Systematic risks can cause chaos within an entire economy while unsystematic risks can only cause issues to a specific organization or sector. There are two types of return that are most focused on: realized return and expected return. Realized Realized return refers to the actual return on an investment over a specific time frame. It is critical to recognize that nothing can alter a realized return. It's really a post-fact number that no action can alter. It merely provides information to investors to help them make wiser financial choices in the future. Expected An expected return is the estimate of profits or losses that an investor may expect from an investment. The expected return is a metric used to estimate if an investment will have a positive or negative net outcome on average. The expected return is often founded on previous data and so cannot be guaranteed in the foreseeable future; yet, it frequently establishes acceptable expectations. Risk and Return Relationship Risk and return are essentially opposite interrelated concepts in the sense that investors seek high returns but low risk. Larger risks equate with higher potential profits in an efficient market. Simultaneously, smaller returns are associated with safer (reduced risk) investments. These ideas outline how investors select assets in the market, as well as how investors establish asset values. Risk-Return Trade-off Risk-return tradeoff states that the potential return rises with an increase in risk. Using this principle, individuals associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns. Risk-return tradeoff is the trading principle that links high risk with high reward. The appropriate risk-return tradeoff depends on a variety of factors that include an investor’s risk tolerance, the investor’s years to retirement, and the potential to replace lost funds. According to risk-return tradeoff, invested money can render higher profits only if the investor will accept a higher possibility of losses. KEY TAKEAWAYS Risk-return tradeoff is an investment principle that indicates that the higher the risk, the higher the potential reward. • To calculate an appropriate risk-return tradeoff, investors must consider many factors, including overall risk tolerance, the potential to replace lost funds, and more. • Investors consider risk-return tradeoff on individual investments and across portfolios when making investment decisions. What is Power of Compounding? • Power of compounding is essentially an act of ‘adding interest on interest,’ i.e. the amount of money you invest will generate earnings from both the initial principal amount and the accrued earnings from preceding compounding periods. Eventually, thus, power of compounding helps grow your wealth over time. There are several investment options in India, offered by leading banks and financial institutions, which credit compound interest on your invested money. Usually, these investment plans have a definitive compounding period, such as annual, monthly, or even daily, helping you leverage the power of compounding as per your needs and requirements. The most exciting aspect of the power of compounding is that your investments accrue interest on both the base capital and the previously earned interest. Overall, the power of compounding helps you build a broad base, which adds on to the previous earnings every cycle. As an investor, therefore, you must keep in mind that the power of compounding lies in its ability to reinvest earnings on your investment. In other words, you should not look to withdraw your returns, at any point before the investment period culminates. Otherwise, you would risk limiting the growth potential of your profits through the power of compounding. The choice of the investment plan and period should depend upon your financial goals and your capability to invest. The farther your goal is, the sooner you must start to invest so that you have enough time to accumulate the desired amount of wealth. Here is an illustration of power of compounding can work on growing your investments over different periods of investments and rates of compounding What is Compounding? “Compound interest is the eighth wonder of the world. He who understands it earns it and he who doesn’t pays it.” The word compounding means that the initial returns or interest that you earned on investment becomes part of the invested capital or principle. Compounding takes place when the returns or interest generated on the principal amount in the first period is added back to the principal amount in order to calculate the interest for the following periods. Thus, it creates a chain reaction by generating returns on the returns as long as your money remains invested in the financial instrument. There are two types of interest, one is simple interest and the other one is compound interest. Simple interest is paid only on the money you save or invest (i.e. the principle capital). Three parameters will influence the rate at which your wealth compounds. These are: 1. Compounding Rate The interest rate you earn on your investment, i.e. the returns you earn. Higher the rate of interest, higher will be the power of compounding and more wealth will be generated. 2. Time Duration The longer your money can remain uninterrupted, the more your wealth can grow with the help of compounding. 3. Tax Rate Tax rates and timing of the tax, you have to pay to the government effect on the wealth accumulation. You will end up with far more money if you do not have to pay taxes at all, or until the end of the compounding period rather than at the end of each year. What Is the Rule of 72? The Rule of 72 is a quick, useful formula that is popularly used to estimate the number of years required to double the invested money at a given annual rate of return. Alternatively, it can compute the annual rate of compounded return from an investment given how many years it will take to double the investment. While calculators and spreadsheet programs like Microsoft Excel have functions to accurately calculate the precise time required to double the invested money, the Rule of 72 comes in handy for mental calculations to quickly gauge an approximate value. For this reason, the Rule of 72 is often taught to beginning investors as it is easy to comprehend and calculate. The Security and Exchange Commission also cites the Rule of 72 in grade-level financial literacy resources. The Rule of 72 can be expressed simply as: Years to double = 72 / rate of return on investment (or interest rate) KEY TAKEAWAYS • • • • • The Rule of 72 is a simplified formula that calculates how long it'll take for an investment to double in value, based on its rate of return. The Rule of 72 applies to compounded interest rates and is reasonably accurate for interest rates that fall in the range of 6% and 10%. The calculation is most accurate for rates of return between about 5% and 10%. The Rule of 72 can be applied to anything that increases exponentially, such as GDP or inflation; it can also indicate the long-term effect of annual fees on an investment's growth. • This estimation tool can also be used to estimate the rate of return needed for an investment to double given an investment period. • For different situations, it's often better to use the Rule of 69, Rule of 70, or Rule of 73. The Rule of 72 can be leveraged in two different ways to determine an expected doubling period or required rate of return. Years To Double: 72 / Expected Rate of Return To calculate the time period an investment will double, divide the integer 72 by the expected rate of return. The formula relies on a single average rate over the life of the investment. The findings hold true for fractional results, as all decimals represent an additional portion of a year. Expected Rate of Return: 72 / Years To Double To calculate the expected rate of interest, divide the integer 72 by the number of years required to double your investment. The number of years does not need to be a whole number; the formula can handle fractions or portions of a year. In addition, the resulting expected rate of return assumes compounding interest at that rate over the entire holding period of an investment. The concept of Rupee Cost Averaging: The market is more unpredictable than before. The rupee cost averaging is a fast-gaining ground market. Investors should start investing early to get a secure financial future. The rupee cost averaging is the best approach towards the investment. The rupee cost averaging helps the investors to maximize the returns on their assets and allows them to balance out their cost of investment by buying during both falling and rising markets. It adds additional units with the same amount of investment in times when the market is collapsing. The rupee cost averaging method eliminates the hassle of keeping an eye on the market on a daily basis and provides the benefit of stable investment. It keeps the investors at peace without the trouble and panic of market volatility. The strategy of rupee cost averaging is a chance for money growth that suits all kinds of investors from beginners to smart investors. Characteristics of Rupee Cost Average 1. Rupee Cost Averaging is best suited for investors who do not have time to monitor the economic market 2. Invest a certain amount of money at a fixed interval, irrespective of the unit price The following are the benefits of the rupee cost averaging: 1. It is an important mutual fund tool that helps investors get maximum value for their invested money in a volatile market 2. It can be used for hedging if the market is moving downward 3. Rupee Cost Averaging negates the effort required for monitoring the stock market on a daily basis 4. It is flexible and offers better prospects for wealth accumulation 5. It is a psychological satisfaction to the investor because the investments are in safe hands 6. The Average Purchase Price Drops When investors invest a round sum amount in a mutual fund, they do not get the chance to average out the investment. In this case, the average price remains equal to the purchase price. In the rupee cost averaging approach, the investment gets to expand. Additionally, as you purchase more units when the NAV is low-priced, the average price of a unit reduces. 7. Saves The Capital From Market Volatility The options traders are seasonal investors; they make volatility their best buddy – the highest the volatility, the larger the profits. Whereas, in a single trading sitting, the high volatility can wipe out the capital of the small investors. The strategy protects the investors from market volatility and saves their principal amount. 8. Affordable Investment Amount Generally, the minimum SIP investment starts at INR 500 per month. The risks are minimal so try and invest more. Before investing a higher amount analyze and monitor the growth of the stocks to get an idea of the market. With rupee cost averaging investors can invest less and can get higher-end returns. 9. Hedging Use The concept of rupee cost averaging can be used for hedging by some investors. The investors divide the total investment into two equal parts and invest the first half in equity SIP(s) and the second half in debt SIP(s). The hedging plan ensures that the NFV never drops below the actual amount. Investors can consult a professional money manager to help them choose the right investing amount for each SIP Three Pillars of Investment Three factors are crucial if you want to invest successfully: analysis, strategy and discipline. “This is a secure investment that pays out fantastic returns”: promises of this kind should set all your alarm bells ringing. Because there is no such thing as return without risk on the financial markets – and no guaranteed recipes for success. Even the most astute investment experts cannot predict the movements of the stock markets with any certainty. However, countless studies show that long-term investment success is based on three factors: analysis, strategy and discipline. Analysis means systematically studying the markets and investments worldwide in relation to both risks and return potential. The investment strategy determines how the assets are allocated in a broadly diversified manner across various asset classes – such as equities and bonds – and markets. It has to be tailored to the individual risk profile and needs of the investor. Discipline is perhaps the most important factor. Once the investment strategy has been chosen, you should stick to it. Even when the stock markets are experiencing turbulence. In other words, you should regularly review your portfolio and re-balance it to match your strategy. Budgeting: Budgeting is the process of putting a plan together to help you not only save money, but also know how to spend it. A budget can ensure you’re not overspending and you can cover necessary expenses. It’s often done monthly and you can re-evaluate it periodically. In business, budgeting works in a very similar way. You can estimate specific revenue and any upcoming expenses. This helps avoid overspending and keep cash flow in check. Budgeting can be used personally and professionally. And it can be for a single person, a business, or individual departments within a company. Managing monthly expenses effectively can make a big difference. It helps you prepare for an unpredictable event or save up for a big-ticket item in the future. Keeping a budget can also ensure you don’t take on any unnecessary debt. Without a budget, you could find yourself with unexpected expenditures. This could lead to difficulty reaching business goals. KEY TAKEAWAYS • • • A budget is simply a spending plan that takes into account estimated current and future income and expenses for a specified future time period, usually a year. Having a budget keeps your spending in check and makes sure that your savings are on track for the future. Budgeting can help you set long-term financial goals, keep you from overspending, help shut down risky spending habits, and more. Importance of Budgeting – A budget helps create financial stability. By tracking expenses and following a plan, a budget makes it easier to pay bills on time, build an emergency fund, and save for major expenses such as a car or home. Overall, a budget puts a person on stronger financial footing for both the day-to-day and the long term. Budgeting is not only useful for individuals who struggle financially. A budget is a stepping stone to your financial goals. It allows you to live within your means and derive maximum benefits from available resources. Budgeting can help as below: 1. 2. 3. 4. 5. 6. Financial Awareness: Budgeting helps to understand your relationship with money. With a budget, you know about your income, spending scope, and saving opportunities. Regular tracking helps to spot patterns and make changes if required. Ultimately, budgeting helps avoid frivolous expenses and inculcates financial discipline. Emergencies: An ideal budget earmarks funds for an emergency and plans for goals like retirement or vacation. Flexible budgets allow you to organize allocation based on your immediate needs. Reduce Debt Exposure: A budget helps you to map out expenses and reduces overspending. In effect, it limits or eliminates exposure to debt or credit facilities. Relieves Stress: Formulating a budget and adhering to it ensures financial independence. While budgeting is not a cure-all, it helps you manage financial decisions and prepare for challenges. Reorganize Expenses: Budgeting helps to forecast those months with tight finances and ones with extra liquidity. To ensure manageable and smooth finances, you may adopt methods to even out the highs and lows in a budget. Helps You Work Toward Long-Term Goals A budget helps you figure out your long-term goals and work toward them. If you just drift aimlessly through life, tossing your money at every shiny, new object that happens to catch your eye, how will you ever save up enough money to buy a car or put a down payment on a house? A budget forces you to map out your goals, save your money, keep track of your progress, and make your dreams a reality. By seeing what money you earn and what money you have going out through a budget, you can create a map for where you need to go to get your goal, whether that is purchasing a home in a few years or going to graduate school. Budgeting can also be used for shorter-term goals. If the brand-new Xbox game or the cashmere sweater in the store window is unattainable right now, then a budget can help you understand what you need to do to get to that goal. 7. Can Keep You from Overspending Far too many consumers spend money they don’t have—and we owe it all to credit cards. The average credit card debt per household rose to $5,805 by the end of 2022, according to credit bureau TransUnion.1 Before the age of plastic, people tended to know whether they were living within their means. At the end of the month, if they had enough money left to pay the bills and sock some away in savings, they were on track. These days, people who overuse and abuse credit cards don’t always realize they’re overspending until they’re drowning in debt.2 However, if you create and stick to a budget, you’re more likely to not find yourself in this position. You’ll know exactly how much money you earn, how much you can afford to spend each month, and how much you need to save.3 8. Can Make Retirement Saving Easier Let’s say you spend your money responsibly, follow your budget to a T, and never carry credit card debt beyond monthly due dates. In addition to spending wisely, budgeting can make saving more achievable. It’s important to build regular saving and investment contributions into your budget. If you set aside a portion of your earnings each month to contribute to your individual retirement account (IRA), 401(k), or other retirement funds, you’ll eventually build a nice nest egg. Although you may have to sacrifice a little now, it will be worth it down the road. Here’s an example of how that could work: Let’s say Trina started a new job last year and wants to take advantage of the employer’s 401(k) plan and matching contributions. She knows that including her own monthly plan deferral from her paycheck in her budget as a recurring expense will help her be consistent in building retirement savings. She’s 36 years old, so she knows that for the 2023 tax year, people her age can contribute a maximum of $22,500 to their 401(k), before employer matching funds.4 So, using a calculator provided by her 401(k)’s management firm, she figures out that she should defer $433 per week, or $1,732 per month, from her salary to max out her potential annual contribution for 2023. She adds that figure into her budget spreadsheet under expenses and makes it an automatic subtraction from her disposable income, to separate her retirement savings from her cash available for other expenses. 9. Helps You Prepare for Emergencies Life is filled with unexpected surprises. When you get laid off, face a costly unexpected home repair, become sick or injured, go through a divorce, or have a death in the family, those circumstances can lead to serious financial turmoil. In these situations, an emergency fund comes in handy. An emergency fund should consist of at least three to six months’ worth of living expenses, and it should be accounted for when budgeting. This extra money will ensure that you don’t dip into other funds saved for long-term financial goals, such as paying off debt. Of course, it will take time to save up three to six months’ worth of living expenses. Don’t try to place the majority of your paycheck into your emergency fund right away. The best strategy is to build it into your budget, set realistic goals, and start small. Even if you put just $10 to $30 aside each week, your emergency fund will slowly build up. Budgeting apps, such as Mint or YNAB, provide tools for setting up an emergency fund, depending on your chosen approach. 10. Can Reveal Spending Habits Building a budget forces you to take a close look at your spending habits. When reviewing your expenses, you may notice that you’re spending money on things you don’t need, such as a cable TV subscription. Budgeting allows you to rethink your spending habits and refocus your financial goals. Taking a look at your expenses, you may see that one month, you spent more money on eating out than cooking at home. By reviewing your budget, you can make effective changes as a result. If you see that you’re overspending target amounts set in your budget for such discretionary items, you may choose to adjust how much you commit to luxury or nonessential spending in lieu of saving for a new car or a major home improvement project that could also add to your place’s resale value. Budgeting helps to Achieve Financial Goals Every business should set financial objectives. Meeting them can indicate if a business had a successful year. Without a budget in place, a company might not be aware of how operations are going. Instead, the business might learn that it lost money at the end of the year. Because there is a better understanding of where the money is coming in and going out, a budget can help a business and its stakeholders stay on track to meet their goals. Attracting New Investors Investors want proof that a company is properly allocating its funds. A well-structured budget demonstrates organisation and dedication to the company. Investors may feel more confident in their decision to invest if they can see budget sheets. This helps them understand how much cash the company expects to bring in and what its expenses are. Budgeting helps for Preparing for Emergencies In business as in personal life, it’s critical to prepare for the unexpected. You can avoid having to take money away from other aspects of running your business by creating an emergency fund with the aid of a budget. Accurately Preparing Taxes A budget can help you prepare the necessary tax information. And it doesn’t matter if you do your business taxes yourself or hire a professional. For instance, you could spend money on tax software or hire someone to file your taxes on a regular basis. Their process will be accelerated by your budget, potentially saving you money and time. Making More Informed Decisions Many businesses will have to make important choices that will affect the flow of money in and out of business. With a budget, you’ll find it simpler to make important choices like how much you can afford to raise salaries. You can also determine whether team members can receive bonuses and what benefits you can provide employees. Plus, you can also explore opportunities to expand business operations. Making some of these financial and business decisions can be difficult without a budget to reference. Creating a Financial Statement Having enough money is going to determine how you build things like a sales budget or operating budget. A financial statement might be an income statement, a balance sheet, or a cash flow statement. But no matter the type of financial statement, having accurate information is key. Identifying income and expense pattern The objective of budgeting is to take note of issues in the income and expense pattern such that the result of income after expenses is never negative. With a few small changes to spending behaviour, you can improve your financial situation at any time. Budgeting is key to personal-financial planning. By listing down the income and expenses of a household, budgeting can help in containing the expenses within the available income and estimate potential savings. The entire process of listing down and itemizing income and expenses provides clarity to one’s financial situation. During working years, we tend to use our income or earnings for meeting current expenses first. A portion of this is saved and invested such that the corpus can generate regular income during retirement years. Different individuals may require different income to meet their current and future needs. Therefore, adequacy of income may not be the same for all and it may also differ across different stages of life. People who have higher earnings as compared to their expenses can save more than people who have income levels that just about meet their current expenses. Young individuals who have just started earning may find their income levels too small to consider savings and investments. Oftentimes, they assume that they can save and invest towards financial goals or retirement only when their income levels increase in the future. However, starting to save for the future only at a point when income levels are high can result in many life goals remaining under-funded. Therefore, it is important to start saving early and build a corpus out of savings such that there is limited or no risk of the accumulated funds being insufficient for the future. This can be achieved through budgeting since no matter the income, there is always a scope to save a portion towards future goals. Financial discipline through budgeting Budgeting is one of the ways of inculcating a financial discipline and saving for specific goals. A budget can help us manage our needs within the available income and continue to focus on savings for future goals. In the future, as we continue to raise our income levels, a budget helps in proportionately increasing the savings for clearly identified goals. Mandatory expenses such as taxes, loan repayments, etc always have to be prioritised while spending from the available income. The essential living expenses such as housing, food, education, transportation, etc also have to be covered. These expenses cannot be avoided, however, you can cut back on them depending upon the available income and savings goals.