What is the most poorly understood area of personal finance?

Success in personal finance is based on some simple practices followed by individuals over a long period of time. Charlie Munger has summarized it well in 15 words:

Spend less than you make; always saving something. Put it into a tax-deferred account.

I often feel people under-appreciate the importance of tax deferral for their investments. I have created a small calculation which highlights how tax-deferral in itself has a huge impact over the long term.

Let us discuss two tax systems applicable to investments:

Accrual Based Taxation: In the above taxation one has to pay tax on the income generated every year and the actual tax is not dependent on whether an investor has redeemed his money. A simple example for this is a fixed deposit where you pay tax on an annual basis irrespective of maturity/redemption of fixed deposits.

Cash Basis of Taxation: Under this taxation structure tax applicability is based on actual redemption/maturity. An investor does not need to pay tax unless he makes an actual redemption. This helps an investor to take advantage of deferred tax until he redeems his investments. Some examples of such instruments are NPS (National Pension Scheme), Mutual Funds (MF)

Now let us assume two individuals earn a similar return over a period of 30 years which is 15% and are taxed at the same rate which is 30% of the income.

Investor 1: Ramesh: An investor invests 10lakhs in an investment instrument (say FD) at 15% for 30 years and is being taxed at 30% every year. (Applicable taxation is accrual basis)

Investor 2: Rakesh: An investor invests 10lakhs in an investment instrument (say MF or NPS) at 15% for 30 years and is being taxed at 30% only at the end of 30 years. ( applicable taxation is cash basis)

When we run these investments over 30 years we realize the importance of deferred taxes on long term investment portfolio. Let us see the results:

Ramesh will receive Rs. 1.81 cr. and which translates to a CAGR return of 10.50% (post-tax). Rakesh will receive Rs. 4.06 cr. and which translates to a CAGR return of 13.61%. (post-tax). That’s a whooping difference of 2.2 cr. just because of deferred tax advantage.

So, what we conclude from the above example is that a simple deferred tax advantage available to us as investors if understood well and implemented in accordance to our long term financial goals will have a significant difference to our long term wealth.

Mental Shift – one small step towards making you richer

In order to properly balance living in a sometimes chaotic world, it is important for you to have beneficial attitudes. This is especially important when managing your finances. With very simple but effective steps, this too can be very easily done.

Here are a few ways of how some of our clients implemented a mental shift to achieve their wealth goals:

1. Mapping every saving to a goal – While plans don’t work often, having one in place helps anyways.

Goal-oriented savings create discipline and accountability in one’s behaviour which helps to remain focused on the objective. Savi & Vinod, a newly married young couple started saving up for a house as their long term goal. With an expanding family and a few emergencies that sprung up, at times they noticed that their contribution towards their dream home had to be re-looked at in a manner that they could still manage the rest of their expenses carefully and not ignore their ultimate goal or delay the time frame of when they charted out to achieve it. Today, after 8 years of starting to invest, they are very close to achieving their goal comfortably.

2. Starting to invest is important, even if the amount is small – Cost of delaying investment is a huge opportunity cost our minds cannot see.

Better late than never applies to everything good in life. We had a set of clients who realised the importance of savings only after the first few years of working. Being brought up in very privileged homes, while the awareness existed, it did not necessarily manifest itself in taking action towards it. Those few years when there was income generated but not invested was a missed opportunity to create wealth. However, now that there’s a start, there should be no looking back.

3. There is world beyond banks when it comes to savings and investments.

This is no new news but traditionally banks are the first thought that come to the mind when thinking of savings and investments. While some of our clients have approached us with the same mindset, they were quick to learn and understand the options beyond banks and have been reaping the benefits of it too.

4. There are no free lunches – Be comfortable to pay experts if you know managing your money is something you are not good at.

Handling money is very critical but you may not be always savvy of the best ways to do it. Luckily, you have us – financial planning experts. Engaging experts who understand your needs and wants and help you plan your finances accordingly, is very easy and doable. Just as practical as it is to pay a specialist who cares for some specific need of yours, paying financial planning experts for their services is no different.

5. Enjoy the process of savings – Just like we enjoy the process of using discount coupons against our purchases.

We create wealth not just to live a comfortable life, perhaps one of our dreams but also to ensure that we are secure in various ways. Being able to create that security for ourselves is empowering and should be a relieving feeling, not a stressful one. After all, working to achieve something is motivating enough when you know that it’s a reward that you’re creating for yourself over time.

Financial literacy among children

Education of a child begins at home and in India, I have not seen many parents talking about “money” and “finances” to children from a very tender age. The conversation is limited to what we can buy for them and vice versa. Conversations around savings, rising cost of living, goals is largely missing. As children, we did save a portion of our pocket money in our “Gullak” (a box where children lock away their savings). But we were not really taught about growing that money.

In my view, financial literacy is incomplete without connecting the dots. Asking the child to save his pocket money is just one part of the whole game. It probably only inculcates a habit of putting away a part of what he owns for future consumption. That is indeed a good start. However, explaining the concept of inflation and the fact that inflation will continue to be a reality is not there. Basic understanding of investment products is something children don’t understand even till they start working. And this lack of awareness throughout our early years – at home, school and college is the reason why financial savings penetration in India is miniscule.

We have started discussing a lot about making children aware of a lot of things. However, implementation is very low. Specially, till we do not see this being implemented as a subject in schools. Anything which is incorporated in schools is automatically taught at home too. A simple subject on “money” will prepare the next generation for financial planning in the right way.

Life lessons that stuck to me

Happy Teacher's Day

Life and failure are the biggest teachers, as they say. Every day in life is a learning of a different kind and some of the lessons learned stick with us forever. And of course, teachers come in different forms – a friend, a colleague, a family member, a mentor or simply even a book or a blog these days.

I’m happy to share that a lot of my thought process is influenced by three people – my dad, Charlie Munger and Warren Buffet. Financial planning being the core of my work, here are some of the most memorable life lessons that I go by which I’ve learned from them.

  • You should be ready to try things. Even if you fail, it is fine. People who succeed are the ones who tried.

I’ve felt encouraged to start a business with this very belief and voila, with the right resources, support and most importantly by trusting my instincts, today we have CAGRfunds.

  • Focus on the work in hand and live in the present.

Time spent regretting about mistakes made in the past can instead be well invested in trying to learn from the same and develop yourself to become better. The analogy is the same as focusing on your goals and working towards them today so that the future is secure.

  • Discharge your duties faithfully and well. There is no alternative to hard work.

No pain, no gain. A simple learning which we all know of. We, at CAGRfunds ensure that we advise our clients earnestly, by thoroughly understanding their needs and ensuring that their investments are made wisely. Having seen the results of working hard is a reassurance of this lesson.

  • Never cheat someone to make money. It comes back in the form of Karma.

Money is precious to everyone. Being in the business of finance has given me enough reasons to understand that, educate people about it and most importantly, to handle it well for other people who trust us with it. Everything connects to everything else – just like karma. You save enough now, you have a lot taken care of in the future. You ignore managing your money now and your money won’t help you much in the future.

  • Avoid envy and resentment. These two are subtle emotions but have serious and bad consequences.

Negative emotions can make you take wrong steps causing losses of various kinds. They can make one act thoughtlessly or hastily – both not advisable in financial planning or even otherwise generally in life. A valuable lesson that applies in business as well as in my personal life.

Happy Teacher’s Day!