Personal Finance 101: How to Manage Money Smartly in Your 20s & 30s 💰

What constitutes Personal Finance?

Personal finance is an essential life skill that empowers individuals to secure a stable and prosperous future. Money is a crucial tool for meeting daily needs, managing unexpected situations, and achieving long-term aspirations, making it vital to understand personal finance. This includes mastering key elements such as income and cash flow management, budgeting, saving, and protecting assets through insurance, as well as effectively managing debt and credit, investing for wealth creation, planning for retirement, and handling taxes. When these elements work cohesively, they enable individuals to establish a strong financial foundation. Understanding concepts like the Rule of 72, the effects of inflation, and the benefits of compounding highlights the value of early and regular investments in transforming modest savings into significant wealth over time. Even a slight reduction in expenses can lead to remarkable increases in savings.

It is well understood and accepted that everyone needs money in his/ her life. So, it is critical to know the fundamentals of Personal Finance. 

There are multiple elements in Personal Finance:

1. Income and Cash Flow
2. Budgeting and spending
3. Saving and Financial Protection (Risk Management)
4. Debt and Credit Management
5. Investing and Wealth Building
6. Retirement & Future Planning
7. Tax Planning

Now, let us understand each of the above elements.

• Income and Cash Flow

Income includes our salaries, wages, business profits, rental income, and returns from investments. Cash flow represents the movement of funds, while assets and liabilities (what we own and what we owe) are essential in determining cash flow.

• Budgeting and spending

Budgeting: Plan for fixing the expenses from the income can be called Budgeting Spending: Actual expenditure for needs and wants.

• Saving and Financial Protection (Risk Management)

Emergency Fund : At least 6 months expenses should be kept aside as emergency Fund.

Insurance : A foreseen events lead to sudden depletion of our hard-earned wealth.

Life Insurance : Protects family if there is sudden death of bread earner.

Health Insurance : With current lifestyle, it is critical to cover entire family by health insurance.

• Debt and Credit Management

Repayment of loans: It is critical that depending on rate of interest, the higher interest loans are cleared first so that the income is not wasted in repayment of loans.

Credit Score: By maintaining discipline about how much we borrow and timely repayment we need to maintain healthy credit scores.

• Investing and Wealth Building

Investing: Investing in stocks, mutual funds, bonds, gold and other options will help us in returns that will beat inflation.

Wealth Building: It is critical to choose investment options which are safe, regulated yet give magical returns.

• Retirement and Future Planning

Retirement: Using retirement plans and National Saving Scheme for own retirement.

Future Planning: Planning for Will and nominations so that there is complete clarity on inheritance of assets without internal conflicts within the family.

• Tax Planning

Taking legal steps to plan and reduce your tax liabilities is key of tax planning. Now let us deep dive and understand easy ways of making 1 crore with small but early investments. Everyone in early earning days has an excuse of not being able to save as much as it required.

Let us take an example of youth who earns Rs 100 and spend Rs 80 but if he/she decided to decrease expenses by just 10% then the saving will go up from Rs 20 to Rs 28 which effectively growth of 40% in savings. Hence it is critical to understand that if we decide we can make it happen.

In Finance, there is Rule of 72. To understand how long it will take to double our investment we need to divide the number 72 by rate of returns. So, if rate of returns is 12% then 72 divided by 12 is 6. This means it takes 6 years to double your investment if the rate of returns is 12%.

Keeping 30 years as time horizon, a modest SIP of Rs 500 per month will fetch Rs 27.7 Lakh and if someone can invest Rs 50,000 per month for 30 years continuously then the wealth created will be worth 27.78 Crores. This simply highlights that it is consistency which pays off and nothing else.

Inflation is key element in personal finance. We need to make provision as one of the major cost that keeps on increasing our expenses is inflation. The prices of all that we consume increase at least by 6% every year and hence we need to compound the cost of inflation while planning our future. As India is growing economy, the impact of inflation is taken care of by growth at which the country’s GDP is growing but elsewhere the inflations could be higher to the tune of 8-10% per year and then the Financial planning needs to robust enough to earn after beating inflation.

Let us now learn the cost of delay in terms of investment. Looking at the example given above it is understood that with investment of Rs 15,500 per month for 35 years one can easily earn about 10.06 Crore at 12% rate of returns. But if the invest is delayed by 12 months then the returns go down by 1.14 Crore and to Rs 2.17 Crore if delayed by another 12 months. Hence the cost of delay in investment could be 10 to 15 times higher of the money which was saved by not investing. Example, if Rs 15,500 per month were invested 12 months later which means Rs 1,86,000/- were saved by not investing but if the same amount was invested on time, it would have fetched Rs 1,14,00,000/- more. Although this is hypothetical example, the underlying message is that of starting early and staying invested to get magical returns.

Finally, it is unbelievable for us to understand the magical returns that can be achieved by compounding.

Based on the above diagram it is understood that it takes 8 years 3 months to earn our 50 Lakh returns at 12% rate of returns, but the next 50 Lakh would come in just 4 years and 1 month and after that in just 2 year 9 months and 2 years later it actually grows by 50 Lakh almost every year.

Importance of Time For Investment:

Rahul and Amit are good friends. Both started working at twenty-five. With the first salary, Rahul started investing Rs 10,000 in a plan that gives 10 per cent returns.

Amit liked to live a flamboyant lifestyle and never thought of investing until he turned forty. As he turned forty-one, he started to invest Rs 18,000 per month in an investment plan that gave 10 per cent returns.

When both retired at age sixty, the principal each had totally invested amounted to Rs 43,20,000.

Even if their principal was the same, since Rahul had started investing at the age of twenty-five, his investment corpus amounted to Rs 4.24 crore, whereas Amit’s was valued at Rs 1.38 crore. Since Rahul had started investing earlier, his investments had grown to triple of Amit’s.

Rahul gave thirty-six years for compounding of the returns. Although he was investing only Rs 10,000 every month, he continued doing that for thirty-six years, and the magic of compounding did the rest.

On the other hand, Amit had invested for just fifteen years. Although he was investing more every month than Rahul, his funds were Rs 2.86 crore less than Rahul’s.

Amit lost a huge opportunity to earn a big amount of money by starting late. Let’s plot their investment journeys in a table.

The Journey of Mutual Funds in India:

1. Mutual funds were introduced in India in 1963 with the establishment of the Unit Trust of India (UTI). The government of India and the Reserve Bank had taken the initiative to set it up. The journey of mutual funds can be divided into four parts.
2. During the period 1963 to 1987, only one mutual fund managed by UTI existed in the Indian market. Unit 64 was one of the most popular schemes back then. Towards the end of 1987, UTI was handling a portfolio of approximately Rs 6400 crore.
3. Between 1988 and 1993, SBI, LIC and other public companies launched their mutual funds. By 1993, the total investment in mutual funds was valued at approximately Rs 47,000 crore.
4. From 1993 to 2003, private companies started their mutual funds. As an industry, mutual funds were moving at a very slow pace owing to a lack of financial knowledge among the people during that period.
5. The period after 2003 is important for mutual funds. UTI was split into two parts. From the older mutual fund schemes, one part was managed by an administrator and the other part was brought under the SEBI regulations, just like other mutual funds. Many foreign mutual funds also entered the Indian market. Some of them were successful in growing their business while others had to merge with or were acquired by other mutual fund companies.
6. Over a span of fourteen years, from September 2009 to 31 May 2023, the Indian mutual fund industry has witnessed remarkable growth in terms of assets under management, expanding from Rs 7.50 lakh crore to Rs 43.20 lakh crore-a significant increase of approximately 5.75 times. Government-backed mutual funds had started operating in 1986 and private companies had joined the party in 1993. As of today, more than forty mutual fund companies operate in the Indian market.
7. As of 31 May 2023, the total count of investor folios has surged to 14.74 crore. Moreover, the inflows in the mutual fund industry, specifically through systematic investment plans (SIP), witnessed.
8. substantial increase. In the fiscal year 2022-23, SIP inflows reached Rs 1.56 lakh crore, reflecting a remarkable growth of 62.5 per cent compared to the inflows of Rs 96,080 crore in FY20-21. (Ref: amfiindia.com)

This upward trend in retail investor confidence reflects a growing trust and optimism in both the Indian stock markets and the mutual fund industry.

Checklist for Successful Financial Planning:

1. Plan your finances as early as possible: Delaying financial planning is injurious to your long-term financial health. Don’t start financial planning when emergencies arise.

2. Stay away from an extravagant lifestyle: Always remember: Celebrating with borrowed money is a short-lived joy and a long-term burden.

3. Avoid overuse of credit cards: One should use a credit card only when it is absolutely necessary. Using it just to avail of offers should be avoided.

4. Avoid comparing your situation with others: Know your limits. Instead of looking at what others are buying, think about whether those items are necessary and affordable for you. Understand your situation before spending.

5. Prioritize savings over spending: Expensive cars, gadgets and lifestyle choices may make you look rich, but will not make you a rich person. Prioritize saving and investing your earnings.

6. Save at least 5-10 per cent of your earnings every month: The first step in financial planning is to save every month and invest it to provide for emergencies.

7. Avoid financial investments you don’t understand: It is best to stay away from the type of investments you have no clue about. In case you still want to go ahead, do so with the help of a financial adviser. Practise caution while investing.

8. Buying an insurance cover is a must: Insurance is not an investment but a productive tool to financially cover yourself or your family members in emergencies. That is why everyone should get health insurance, accidental insurance and term insurance.

9. Invest for the long term: To get the benefit of compounding, invest a major portion of your savings in long-term options.

10. Regularly re-evaluate and review your financial strategies: You may have planned a robust financial strategy but failed to implement it or made a few wrong financial decisions. To understand this, you need to frequently review your financial strategies.

• Re-evaluation: The goals based on which we decided on our investments in the past may change. For example, you may feel that saving money for your children’s higher education is more important than buying an expensive car, which was your earlier goal.

• Review: We can re-prioritize our goals based on our current needs, after periodical reviews.

11. Discuss your strategy with your partner: Have a healthy discussion with your partner about your financial goals. Whether your partner is an earning member or not, you should consider their point of view as well.

12. Be ready for change: Life is full of surprises-be prepared, mentally and financially, to face any unexpected situations that may arise.

13. Read up on financial matters: You should regularly engage with financial newspapers, magazines, blogs and social media pages. Also, you should have books on the subject handy in your personal library.

14. Self-confidence is essential: No one can play your part better than you. That is why you need to study the subject of finance in depth and make the right decisions to get the most out of your wealth.

Stay Away from these Financial Mistakes:

(Reference: from money work book by Abhijeet kolapkar )

Types of Personal Budgets :

Preparing a budget is not a difficult task at all. Once you understand it, you can easily prepare both your family and personal budgets.

1. The 50-30-20 budget

• Your income is divided into needs, lifestyle and savings in a 50-30-20 ratio.
• Daily needs: 50 per cent of your income goes towards daily needs, such as daily expenses, home rent, groceries, loan EMIs, utility bills, etc.
• Lifestyle needs: 30 per cent of your income goes towards gym, club membership, shopping, eating out, Internet, partying expenses, etc.
• Savings: 20 per cent of your income is set aside for not just savings but also for investments, emergency funds, insurance, etc.

This type of budget accounts for your needs, wants and future needs too.

2. The 50-20-20-10 budget

This is similar to the 50-30-20 type of budget. In both, 50 per cent is allocated towards daily expenses. But out of the rest, only 20 per cent is allocated to lifestyle expenses instead of 30 per cent and the 10 per cent that remains is left for long-term investments.

 50 per cent is for needs

20 per cent for wants

20 per cent for savings

10 per cent for investments

Here, the meaning of long-term investment is primarily any investment that is high-risk, high-returns. Example: shares, mutual funds, gold exchange traded funds (ETFs), etc.

3. Zero-based budgeting

• In this type, nothing is left at the end because it is ensured that your total income, minus your expenses, equals zero. Once all the needs. are met, the balance amount is used for future planning, investment, social work, enjoyment, etc.
• Every rupee serves the purpose because you’re telling every single rupee where to go.
• This type is popular in Western countries and is pretty successful.