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Re-visit of personal finances process in the country

Personal finance is the management of financial resources. Saving helps us to overcome significant problems in our lives. To manage our income means to start a journey towards financial freedom. This does not necessarily mean having a luxurious life, but to adopt effective measures of achieving a certain comfort efficient management of money for each individual brings a qualitative growth. Money is a tool, the means by which we support our unique values and priorities. Therefore it is important to create a financial plan, savings strategies. Goals and opportunities for individuals to save are different and it is difficult to find a suitable solution for all.

Many new investors don’t understand that saving money and investing money are entirely different things. Saving money is the process of putting cold, hard cash aside and parking it in extremely safe, and liquid (meaning they can be sold or accessed in a very short amount of time, at most a few days) securities of accounts. Saving money comes before investing money. It is like the foundation upon, which financial house is built, as it is savings that will provide with the capital to feed the investments. Savings could be of two types. One, the savings should be sufficient to cover all the personal expenses, including mortgage, loan payments, insurance costs, utility bills, food, and clothing expenses. Secondly, for any specific purpose which requires a large amount of cash in five years or less should be savings-driven, not investment-driven.

On the other hand ‘investing money’ is the process of using money or capital to buy an asset that could be a good probability of generating a safe and acceptable rate of return over time. True investments are backed by some sort of margin of safety, often in the form of assets or owner earnings. The best investments tend to be so-called productive assets such as stocks, bonds, and real estate.

Cash deserves respect. If you’re struggling to curb your urge to splurge, you may want to keep better track of your recent purchases. The impulsive spenders tend to conveniently forget just how much they spent the last time they indulged. Impulsive people are willing to pay more because they mistakenly believe that they did not spend much of their budget yet. People with poor impulse control are especially bad about tricking themselves in order to justify a future splurge. But they only do it when they’re debating a future indulgence. When they’re not faced with an immediate temptation, their memory of a past event such as a previous purchase is more likely to be accurate. However, the self-disciplined consumers may also deceive themselves. But in their case their self-deception is more likely to be helpful rather than harmful. Frequent savers might subconsciously convince themselves they spent more in the past than they actually did in order to discourage future spending. The possible reason for this effect is that non-impulsive people, who are generally high in self-control, may be employing a counteractive self-control strategy in order to avoid overspending. By telling themselves they spent more than they did, they’re motivating themselves to work harder toward their long-term goals.

Personal finance is the ugly step-child of finance. By contrast, the average household saves in order to spend. Regular people need to finance key life expenses like a house, education, healthcare, and retirement. Making sure incomes and investments stretch to cover these costs, in addition to life’s many surprises.

Goal setting

It sounds obvious, but we never do it. In finance, like in life, if we set a goal we are more likely to achieve it. If our goal is saving enough money to buy a house in five years, we will save and invest with that in mind. If our goal is to ensure an income in retirement that’s 70% of our current salary, that will determine your investment strategy. Sadly, the financial industry pays lip service to goal-based investing, but it rarely offers investment advice that actively targets a specific goal. Instead, people are told to invest based on some vague notion of their risk tolerance and investment time horizon. A more useful way to devise an investment strategy is to set goals.

 

There should be two steps. First, defining low-risk portfolio. Which means short-term bonds or cash, but what counts as low risk really depends upon goal. If you have a long-term savings goal, short-term bonds aren’t low risk because they don’t keep up with inflation. Secondly, dividing the saved money into portfolios of risky assets (stocks, commodities, certain kinds of bonds) and no- or low-risk assets. The right split depends on how much money you have and your risk tolerance.

Diversity

There is a confusion between diversification and risk management. Diversification is an important part of any investment strategy; in fact, it should be among the first things you do. A well-diversified group of assets is ideal for your risky portfolio. But diversification merely reduces idiosyncratic or unnecessary risk, or the risk one asset will gain or lose value because of factors unique to that asset. It does not remove the risk that the whole market will crash, taking everything down with it.

Achievement

Index funds are one of the best inventions in the history of finance. They allow ordinary investors to get low priced diversification. Often, we need to pay for risk management. With insurance, someone takes on our downside risk, like the risk our house will burn down or we will outlive our savings. This will never be free because risks are not totally eliminated but transferred to someone else. The party that takes on the risk will want money in return, and sometimes that is worth paying for. The best hedging strategy depends on goals. There is no universal hedge. Sometimes, you we can hedge by investing in risk-free assets. Other times, we hedge by buying an asset that goes up when your other holdings go down. Identifying the right hedging strategy is hard and sometimes takes expertise.

Financial products and advice aren’t often transparent on fees. There is no reason for this to be complicated: Make you know what you are paying for and what it buys for you. If no one can explain it to you in terms you understand, the product or service is not right for you.

The unexpected

No matter how well we plan our finances, things will always come up as we cannot foresee. It could be a car accident, illness, or job loss. The best way to manage these risks is liquidity, or savings that one can readily access and will always be there for you.

The writer, Mr. Nazir Ahmed Shaikh is a freelance columnist and is an academician by profession. Currently he is associated with SZABIST as Registrar and could be reached

nazir.ahmed@szabist.edu.pk.

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