What does it mean to be financially responsible? This may seem to be difficult question to answer by most of us. One must have heard of the saying "to live within your means". Though this may be at heart of being financially responsible, it hardly is enough in today's world. Being financialy responsible today is probably much more than this. This article gives an insight as to what would constitute a hoslistic financial responsibility for any person.
Managing debt prudently:
Though taking credit or debt today is no longer considered a taboo, one should make sure that it is only for basic necessities and not for luxury and convenience items. Merely being able to pay your EMIs and credit card bills doesn't give you the licence to go out and spend heavily. Remember that for every loan that you take, think that paying interest means that you are spending more for that item than the purchase price and as such, avoiding paying interest on anything should be a major objective. Of course, when it comes to the cost of housing and car, avoiding interest is almost impossible for most of us. In such situations, minimizing the amount to borrow and the interest payable is the most responsible action. Typically for housing loans, it shouldn't cost more than 2 or 2.5 times of your annual income. Another estimate of housing loan affordability is that it should not cost more than 30% of your monthly take-home pay. But in case you have already borrowed more than your comfort level and now feeling the pressure, it's time to spend much more responsibly and reduce your debt by paying off the high interest rate loans earlier.
Use of credit cards is good, as long as one is not encouraged to spend more freely. Credit cards are handy because they eliminate the need to carry cash, defer your payment for a while and are helpfull in times in an emergency.
Insuring for future:
Financial responsibility means being prepared for the unexpected. It means that you and your family are ready, financially, for any eventuality, in case of any temporary or permanent loss of income and large sudden and/or prolonged medical or other expenditure. But having insurance is not enough and one must have adequate insurance cover given his/her standard of living and background. Insurance is a broad term and includes life, health, property & valuables, car, etc. For life cover, as per the human life value concept, it must be the multiple of your annual income and years to retirement. Thus, if your aged 30, earning Rs.4 Lacs p.a. And retiring at age 55, your life cover should be Rs.1 crore (Rs.400,000 x 25 years). This amount can be further adjusted for existing investments, liabilities, lifestage and family background, etc. For health insurance, looking at the present medical costs, one may roughly estimate it to be between 3-5 lacs per person. To be responsible means to buy both health and life insurance as early as possible in your life for a longer duration. This way you are assured of better coverage, cheaper premiums and more choice. For other insurance covers, its better to think first and judge later.
Investing for goals:
Spending without investing for future goals is something that every prudent man will do. Ideally every household must invest at least 10-20% of their income subject to the kind of goals and existing investments you have. The more you invest, the better it is. A point here to note is that saving is different from investing. While saving is mere "not spending", investing is more about "generating returns" on your savings. Any savings or investment avenue that gives you less than your inflation rate after tax effect is no real savings at all. To be responsible is to be practical and invest in avenues that give you positive post tax real returns, matching your risk appetite and desired objectives.
Investing can be goal oriented or otherwise. In case it is goal oriented, it is always driven by required amount and required rates for a defined periods. Independent of goals, you can also follow asset allocation method for choosing the right mix of assets & products in your portfolio. If you are investing for long, say above 5 year, equity related investments would be good option. You may even start a SIP or Systematic Investment Plan in these mutual fund schemes an ideal way to invest in equities.
Among the goals that one invests for, one of the most critical is that you save for yourself – Retirement. Saving for child education and marriage has probably decreased a bit in intensity with educational loans abounding and children being independent and earning decently even in starting years of their careers. Saving for retirement though has become more critical with longer life spans, higher medical costs coupled with greater probability of new age diseases and nuclear families. Being responsible is investing rightly for your and your family's future goals.
Paying Taxes wisely:
Paying taxes is an obligation and evading taxes is a crime. But reducing tax liability smartly by using the benefits offered, is perfectly justified. Managing tax payment and tax returns is a non-pleasant but an important activity for every earning member. Being prudent in saving taxes means that you have chosen that right investing products and time to maximise tax breaks and that you have made appropriate use of the perquisites, allowances, deductions offered. Typically different types investments offer different tax breaks while investing, withdrawing and on returns / interest earned. Being responsible means that you pay all your legal dues and file returns on time.
Planning and Budgeting:
Having a comprehensive Financial Plan prepared by your advisor is the most important financially responsible step that you will take. Having that plan in your hand will give you the answers to the critical questions in your financial life. Often people ignore this, but its surely is worth it, even if you have to pay for it. Be sure that you disclose all your material details properly, else the financial plan will be meaningless. Further, having plan is just not enough, its just the beginning. Follow your qualified advisor's advice in structuring your finances and planning for your objectives in life followed by regular review of the plan and its progress.
At a personal level you can also manage your finances in a much better way by having your budget defined before-hand. Contrary to belief, budgeting is very simple and very less time consuming. The only part difficult is being prudent and sticking to it. Observing your expenses for a couple of months can throw up great surprises for most of us. You should know where your money is going. Business owners know the importance of understanding their cash flows and balance sheets; as a result, no successful business exists without a budget. Neither should you.
Financial responsibly means doing what you have to do to take care of your needs and the needs of your family. To make this happen, your focus should be only on yourself. A prudent being would never compare self to neighbours, friends or relatives and let them set the bar for spending habits or standard of living. Its better to be modest and safe than be flamboyant and sorry. Being financially responsible doesn't really mean that you have to scrimp and save, unless if thats the only way out. Every family has to enjoy life within own means. Likewise its also important to no get carried away by great offers, quick-money schemes, hot tips and rising markets. Ultimately, financial responsibility means living within your means, regardless of the level of those means. Only this way can we ensure a peaceful, worry-free future for ourselves and our family.