Learning the Basics

 B T :Dipak Mondal  :Edition: February 2013
Tips to know your financial literacy quotient

Knowledge can make all the difference between financial success and failure. For instance, what happens if a person, the family's sole bread-winner, buys insurance in the name of his wife and children instead of himself? If he were to die, his family would not get a penny from the insurance company.

Every time such cases of imprudence are highlighted, the lack of understanding of financial products among people comes to the fore.

Even if the reason for the wrong choice is mis-selling by intermediaries, investors cannot put the entire blame on others, as a part of the problem is their reluctance to know about their finances or financial products, in short, their lack of financial literacy.

Here is what a person must know and do if he wants to keep himself financially safe and sound.

Keep track of cash flow: 
With multiple credit cards, there is always a chance of spending much more than you earn. There is high likelihood of falling into a debt trap if you do not assess your income and expenses. Knowing your cash flow is the first step towards financial literacy.

Basically, being financially literate means knowing how much money you have and how much you need," says Anil Rego, chief executive officer and founder, Right Illustration: PRAGATI Horizons, a financial advisory firm.

"Financial planning is not only about investment planning, it's about money management as well," says Jitendra Solanki, a New Delhibased certified financial planner.


Maintaining a note book with income and expenses entered into different columns is an age-old way of keeping tabs on cash flow. If you are not alien to computers and internet, you can do so with the help of online personal finance applications such as myuniverse.co.in, perfios.com and arthyantra.com which are available for free.

Charting out financial goals: 
Setting financial goals is the second-most important indicator of your being financially evolved.

In the absence of clear financial goals, investments become just a tax-saving exercise or thrill-seeking speculative stock trades. Knowing how much to invest and for which goals helps you plan better.
Maintaining a note book with income and expenses entered into different columns is an age-old way of keeping tabs on cash flow. If you are not alien to computers and internet, you can do so with the help of online personal finance applications such as myuniverse.co.in, perfios.com and arthyantra.com which are available for free.

Charting out financial goals: 
Setting financial goals is the second-most important indicator of your being financially evolved.

In the absence of clear financial goals, investments become just a tax-saving exercise or thrill-seeking speculative stock trades. Knowing how much to invest and for which goals helps you plan better.


"Set financial goals, save for them and make good investment decisions," says Arup Mukherjee, assistant vice-president, strategic business unit education, National Stock Exchange.

If you know how much you will need for, say, your child's education, in 10 years, you can invest regularly for the goal. The investment will depend on the product you invest in. In fixed deposits, your post-tax return will be 6-8%. In equities, you can expect to earn 10-12% a year over the next 10 years.

To know how much you need to invest, you can use online calculators on websites of mutual funds, insurance companies and banks.

Know the financial products: 
A person buys just Life Insurance Corporation's traditional schemes as they serve his tax-saving, insurance as well as investment needs. He is, however, unaware of the fact that the schemes will give him just 6-7% return a year, which may not be enough to meet all long-term financial goals.

Choosing financial products that suit you is important . "Understand the financial products you may need throughout your life, including bank accounts, mortgages, retirement savings plans and basic instruments such as stocks, bonds and mutual funds," says Ambarish Datta, managing director and chief executive officer, BSE Institute.

Equally important are the benefits and risks associated with a product. Equities have volatility risk, bonds have interest-rate risk (bond prices fall as interest rates rise), fixed deposits have default risk (the borrower may be unable to pay back), while real estate has liquidity risks.

"Understanding the risks and benefits of a financial product by talking to the agent or conducting basic research is an imperative before taking an investment decision," says Bimal Gandhi, chairman, Ameriprise India.




"Most of the times, investors look at just the past returns, but it is equally important to understand the risks the product carries," says Rajesh Kothari, managing director, AlfAccurate Advisors.

Importance of asset allocation: 
Don't put all the eggs in one basket. You should allocate money to different assets-equity, debt, fixed deposits, gold and real estate- based on your needs, risk-taking ability and age. Diversification limits losses when one or more asset is not doing well.

"Investors must understand the importance of asset allocation. They must invest in different assets whose benefits and risks they understand," says Deepak Kumar Chatterjee, managing director and CEO, SBI Mutual Fund.

Know the charges:
Issuers and sellers of financial products charge different fees that affect the cost of purchase and hence long-term returns. It is, therefore, essential to know how much you are being charged.

Banks charge for most services such as online money transfer, loans and issuing demand. These can have a huge impact on your monetary outgo.

Similarly, investment products such as mutual funds, insurance and unit-linked insurance policies come with multiple charges such as fund management fee, mortality fee and distributor's fee. Buying shares requires payment of brokerage and demat charges. Real estate involves brokerage and registration charges while buying gold involves making charges and taxes.

Tax implications: 
Tax can take away a big chunk of your investment and salary if you do not plan well. Other than the salary, returns from investments-interest, capital gains and dividends-are also liable to tax. Then there are service tax, stamp duty and securities transaction tax (STT).

While you cannot escape some such as service tax and STT, you can lower the tax on capital gains or interest earned by tweaking your portfolio.

All you need to know is the applicability (or non-applicability) of tax on different financial products.

Know the basic financial math: 
This can be a little tough, but when it comes to managing your money, you can go that extra mile. All you require is understanding of basic financial mathematics such as compound interest and Rule of 72.

You may have a mental block when it comes to numbers, but with all kinds of calculators and financial applications available online, mastering a few basic formulae is not tough.

"Many people understand the benefits of compounding and the difference between simple and compound interest. The reason is simple- they understand banking better than, say, a mutual fund," says Chatterjee of SBI Mutual Fund.

ASK THE RIGHT QUESTIONS
If you know the things mentioned earlier, it helps if you ask the right questions about the product you are being sold. This way there is less chance of you being sold a product that does not suit your needs.

So, if an insurance agent tells you about a "savings plan" with "free" insurance, ask about the different charges that you will have to pay and the returns that can be expected and compare them with what other products are offering.

Financial literacy is a vast subject and the more you know the better it is. However, you can be a successful investor without being a financial wizard. All you have to do is get the basics right.