LEARNING OUTCOMES The learning from this chapter will enable students » get familiarized with the concept of financial literacy > know why financial literacy is important for every individual > understand the basic terms associated with financial literacy | INTRODUCTION The whole world has agreed that India is a country with massive growth potential and opportunities. But there is one big social evil which has continuously put a dampen on this growth potential ie, poverty. According to the Oxford dictio- nary, poverty means “the state of poor”. Now, there are many reasons for such widespread poverty in the country and one of them which is agreed by all is a lack of financial knowledge. Everyone knows that resources are limited be itat a world level, national level or personal. The ability to derive the most out of these scarce resources is the need of the hour. Thus, we can say that financial literacy is the first step out of poverty. The research by Linfield (2011) revealed that people belonging to the age of 25 to 34 years is the “fastest-growing bank- Tuptcy demographic”. There exists a strong argument for the requirement of financial literacy among all demographics. This book aims to provide basic skills one must possess to attain financial self-sufficiency for oneself and the family. FINANCIAL LITERACY Financial literacy refers to the knowledge and understanding of various finan- Cial skills one must have to make efficient and informed financial decisions. It included skills related to saving, investment, taxation, etc. A financially literate Person is better off at attaining his/her life goals than a non-financially literate one. The main objective is to safeguard oneself from financial fraud and distress. 1314 UNIT 1; FINANCIAL PLANNING AND FINANCIAL PRODUCTS Financial decisions are something which an individual is bound to make through- out his/her life time, one might as well learn about them. Warren Buffet aptly defined the need for basic financial know-how. He said that “If you buy things you do not need, soon you will have to sell things which you need”. IMPORTANCE OF FINANCIAL LITERACY Financial literacy education is important because it provides knowledge and skills for effective money management. Without financial knowledge, the actions and decisions that a person makes or does not make regarding savings and investments will not have a solid foundation. Financial literacy education helps to better understand financial concepts and allows one to manage their financ- es effectively. In addition, it helps to manage money effectively, make financial decisions and achieve financial stability. In addition, financial literacy provides in-depth knowledge of financial education and strategies that are indispensable for financial growth and success. It can also help a person get out of debt by adopting the best debt strategy. It may impact the future of the youth through the most popular skills which are budgeting, cost management, debt repayment, and understanding of risk-return coordination on investment products. Acquiring these skills will require an understanding of basic financial concepts such as time, money, interest, annual sum and opportunity fees. With the diversity of credit products available in the market, such as credit card debt, debit card withdrawal opportunities and EMI, financial literacy is becoming increasingly important. Understanding debt and having a basic knowledge of finance will help people use these products responsibly. Financial literacy always teaches people how to make important financial deci- sions. It also increases financial discipline and financial opportunities. This will lead to significant lifestyle changes such as saving money and investing regularly, managing debt effectively and achieving life goals effectively. In addition, financial literacy will ensure one’s financial well-being and will also protect people from financial fraud. A lack of knowledge of these skills leads to financial illiteracy. Financial illiteracy education leads to budget mismatch, high-income expendi- tures, debt collection, poor credit assessments, victims of financial fraud and other negative consequences. Financial Literacy could be considered one of the most important forms of ed- ucation in anyone’s life. Consider this example, if I give you $100 a d . to invest it somewhere, 90% of people under such conditions we a es you consider the stock market or mutual bonds and are likely to put th Ouldn’t even their bank accounts. However, if we teach them the way they ca ‘© money into percentage of return on mutual funds with slightly more risk N earn qa greater are likely to invest in mutual funds, such is the power of financial prone people al lit €racy, MostCH. 1: FINANCIAL LITERACY 15 of the tme, we are faced with situations that want us to a rational informed decision, like pow much should I save today to get $2m when I retire? pow much should we spend on credit to not degrade our credit score? Most importantly, an important part of our career as well, how much tax should | pay and how to invest Properly to not pay taxes on our income? jt would be very hard for someone without appropriate financial knowledge to take correct decisions in all such concerns. On a career basis, one needs to plan out his career and based upon the plan, he needs to take the decision that can help him achieve his goals, like mentioned earlier, how much should I save today such that I have & 2,00,00,000 when I retire? For someone who hasn't heard about annuities and how things work, it wouldn’t be possible to take a decision. So financial literacy is equally important in our careers as well. Today's world is connected more than ever before so financially empowering people shouldn't be as complex as it used to be. One can make people aware of hundreds of courses available online and encourage them to take them up, online forums on websites like Reddit or groups on Facebook can help people to spread awareness among people about the importance of financial literacy. Such methods are new and require people to connect with others to get bene- fitted. For people who fail to do so, the best way in the real world in organising workshops and meetups wherein people learn aspects of the financial world and express the issues they can face along with it. A financially literate person can measure his/her long-term/retirement goal with ease and accuracy. He/she then can accordingly plan for a retirement fund and annual/monthly withdrawal during retirement as well as an inheritance at death. Thus, it can be said that financial literacy plays a very crucial role in the successful financial planning of an individual. In the current scenario, more people are interested in tax-free investment/ savings options. Thus, giving them knowledge about the non-traditional tool of investment and savings like SIP and mutual funds can help them to earn a better return on their investment and to create a larger retirement fund. Even though, an individual is aware of high-yielding investment and savings op- tions the investor does not use them due to their risk aversion. This is because these investment options carry risks higher than tax-free securities. Thus, a Person with lower risk aversion does not use these non-traditional investment and savings options. Thus, individual characteristics affect retirement planning. It is advisable, if an individual lack the much-needed financial knowledge and skills, they should not hide away from their lack thereof and go for professional elp ie, Financial Advisors. These financial advisors are there to assist you in making the most appropriate financial decision depending on the circumstances.TAL PLANNING AND FINANCIAL PRODUCTS 6 uni 1: FINANC 1 i i erson 1S mmarize 4 financially literate P' rd ared for the financial emergencies @ Much better preP ; @ More capable of achieving his/her @ Much more confident in his/her fit d out about the finan financial goals nancial decisions Is less stresse' cial obligations @ Is FINANCIAL LITERACY BASIC VOCABULARY _ a FINAN Annual Percentage Rate i ich is paid by a person on the mon- Rate or APR is the rate which is pal See fa year. It is indicated in the form of a percentage. Annu he course 0} ey borrowed in t Asset An asset is something which holds monetary value ie. it can be converted into et is to generate returns and create wealth. These cash. The purpose of an ass / creat assets can be tangible or intangible and include things like investment, real estate, cash, intellectual property, etc. Bait and Switch Bait and Switch is a type of retail sale fraud/scam where the seller tries to persuade customers by advertising deals which seem attractive but later on, are found to be non-existent or inferior and thus the buyer is offered an upsell. Such deals are too good to be true. It is an illegal trade practice and is subject to punishment when found guilty. However, it is very difficult to prove such malpractices, therefore the customers have to ensure vigilance on their part. Bank Abank isa arate financial institution which offers financial services to people ge from saving, borrowing, investment, etc. They are considered to be the key players in the disseminatio: eracy and the promotion i , hi °y PI a in of financial lit Bankruptcy eee which arises when a person is not able to assets of the person decla a this, a legal proceeding is initiated where a standing liabilities and shila wt are sold in order to pay off all the one ns. It i : are unable to honour their obligations. also a fresh start for the People whoCH. 1: FINANCIAL LITERACY 17 Borrower Aborrowenis a person who receives or uses something which belongs to some- one else. The intention behind this is to return it bank within a specified time period often with some additional interest. For example, If a person takes a loan from a bank such person will be called a borrower of the bank. Budget A budget is a blueprint used to keep track of the income and expenses of an individual. People indulge in making budgets in order to ensure the appropriate utilization of their funds and to identify the areas where control is required. It is a major step towards financial discipline and attaining financial goals. Comparison shopping Comparison shopping is one of the popular strategies used by people to ensure efficient spending. Under this, while making a purchase customers indulge in comparing the alternatives which are available for the product they need to buy on different parameters and rank them. The one providing the most utility is preferred with the least cost being preferred. Every individual is advised to practice comparison shopping to stay financially disciplined and not indulge in impulse buying. Credit Credit is a financial arrangement between two parties where one party borrows the money and the other provided it. This facility helps people in making big purchases like car or house property which require a large sum of money and is very difficult to afford if require payment to be made in a single instalment. The cost is distributed across many years which reduces the financial burden on an individual. Examples of credit are credit cards and bank loans. Credit card A credit card is a card facility provided by banks and other credit institutions where the cards can be used to make financial transactions up to a certain limit ‘ora specific time period say 1 month. All the credit accumulated after the spec- ified time period can be paid off by the lender afterwards within a given time Period. Default in repayment results in default charges. The credit is available til the card expiry date. Credit report Acredit re i ing the credit history of an individual. It states ort is a document stating : : a 4 all the important information about an individual's credit position like pending3 unit 1: FINANCIAL PLANNING AND FINANCIAL PROD yong 1 id off, any default in loan repayment, etc. This report helps the ne customer's credit score and depending on the score loans, loans p@! garding the availability and non-availability of the credit. lender to determine decisions are made re' Credit score : foe d is a three-digit number which represents the likelihood that the A credit score i t. It is calculated based on th i honour their debt or no c bas . borrower wil ein the credit report. In India, the credit score is issued RB} meet a anies like CIBIL, Equifax and Experian and it ranges from 300 ag00. The higher the score more is the chance of receiving credit at a lower eee rate. The ideal range of credit score is between 750 to 900. Creditworthiness Creditworthiness can be defined as the extent of confidence a lender can have in the borrower concerning his/her ability to loan repayment. It is determined based on how one has managed his/her past debts and obligations. Debit card A debit card is a card facility offered by banks to their customers for instant withdrawals of money from their savings accounts. It can be done through ATMs and micro-ATMs in rural areas, Since the amount is directly deducted from the bank account it does not cause any burden of debt on the customer. The banks charge a nominal fee for such a facility. Debt Debt is the money that is borrowed by one party from other. They can be in the form of personal loans, credit cards, car loans, home loans etc. They facilitate big purchases by individuals. Debt can be secured, unsecured, revolving, etc. Default a is a situation where the borrower fails to honour his/her financial debt nor pao mn * the due date, Default is the second and more serious stage of ra yl hat follows the stage of delinquency. Once a default happens, the reports it to the credit bureaus and sells it to the debt collection agency. Emergency fund An emergency fund is the pool of money which is kept aside for some uncertain events which may or may not occur and if they happen they have a detrime, tal Impact on the financial well-being of an individual. These uncertain events | . clude job loss or unexpected medical bills. The idle size of the emergency fineCH. 1: FINANCIAL, LITERACY 1.9 should be between 6 months’ salary to 12 months’ 5 ‘ alary. It should be kept in liquid assets which can be easily converted into ‘ash. Expense From an individual’s point of view, the ex is spent by an individual on his/her livel education, travelling, housing, are justified and not incurred pense is the amount of money which ihood, It included spending on food, etc, One should make sure that his/her expenses on impulse, to ensure financial discipline. Income Income is the money earned by an individual through different sources like employment, business activity and investment. It is the main source of finance for sustaining one’s livelihood. Income can be classified into gross income and het income. Gross income is the total income earned irrespective of any costs. Net income is the total gross income less all the costs (expenses). Interest Interest is the certain percentage of the principal amount that the lender changes from the borrower for the loan facility. It can be classified into simple interest and compound interest. Simple interest is calculated on the initial principal amount borrowed. Compound interest is calculated on the principal amount as well as the interest accumulated throughout the years. Need vs. Want The essence of personal financial planning is the classification between need and want. The need is something which an individual cannot compromise i.e., such expenses are bound to incur like food, education, shelter, etc. Wants are something which an individual desire and they can be postponed like a luxury watch, designer bag, etc. Opportunity cost Opportunity cost is the value one loses while choosing between two or more alternatives. For example, an individual has to decide whether to sell his/her investment today hold it for some more time and then sell it. If he/she choos- es to sell it now, the opportunity cost will be the value of gains which he/she could have earned if he/she held his/her investment for more time. It applies to any life situation.1.10 UNIT 1; FINANCIAL PLANNING AND FINANCIAL Pay yourself first 4 P is a budgeting strategy where like (rr money a the need. While budgeting a certain su™ on! are ) ey is Pay yourself first or PY! ing is also deemed as a aside as saving and once all the needs (including saving, person moves to satisfy wants. Thus, a certain sum of mon savings account each month without compromise. Predatory lending Predatory lending includes all the lending sive terms and senditions, high and unjustified lending rates, mers towards involves the use of aggressive advertising in order to lure bor! e what they loans which are too good to be true and often force them to include pred- don’t need, don’t want and can't afford. Examples of the practice i debt, and atory mortgages, payday loans, overdraft loans, excessive credit cal instant tax refund loans. : d abu- om fair an malpractices like unt fees, etc: It Principal The principal is the amount of needs to be repaid. It does not include interest. money which is borrowed by an individual and Rule of 72 Rule of 72 is a quick and instant technique to estimate the amount of time (in years) it will take to double an investment at a given rate of interest. It is cal- culated by dividing 72 by the rate of interest. For example, if the rate of interest is 10% then the investment will double in approx. 7.2 (72/10) years. The time period estimated is in the presence of compounding. Time value of money Time value of money or TVM is a concept which states that the value of a ru- pee today is not the same as the value of a rupee in the future i.e., with time money loses its value or purchasing power. Thus, people prefer money today rather than tomorrow unless some added value is offered which compensates for the loss in value due to time. Wealth Wealth is the aggregate value of the assets held by an individual in his her name. Wealth ensures an individual's and his/her family’s economic eee — and financial security. Often wealth is confused with income which is eine Wealth is a stock concept whereas income is a flow concept. The net poe f an individual is a common expression of wealth. nme aisCH. 1: FINANCIAL LITERACY 1.11 The process of attaining financial literacy is never-ending. As the circumstances change, so does the required financial skills. So, it is advisable to start as early as possible, otherwise, there is no age limit to become financially literate. REVIEW QUESTIONS 1. What do you mean by financial literacy? 2. Why is financial literacy important? 3. Explain the following terms. a. Comparison Shopping b. Predatory Lending c. Pay yourself first d. Bankruptcy e. Opportunity Cost f: Bait and Switch g. Rule of 72 PRACTICAL EXERCISES 1. You just started this course on financial literacy, so you must be curious to know that if being financially literate is so important then are people doing something about it. Thus, you are required to conduct a financial literacy survey and see how it differs among different demographics. 2. Raj is your friend. He informed you that he wants to buy a laptop. When you asked which laptop he wants to buy and how he arrived at the deci- sion, he informed you that he selected it randomly without any research. Since you just started with the course of financial literacy in your cur- riculum, his approach didn’t fit you well. You are required to explain to him the importance of comparison shopping and why thorough research is important. Also, assist him in performing the analysis and arriving at the final choice. Document the whole process. (Classify all the available alternatives based on their attributes and rank them according to his preference).Saving and Spending Management CHAPTER\ LEARNING OUTCOMES The learning from this chapter will enable students » how to differentiate between needs and wants and why » get accustomed to the concept of spending management and its impor- tance » how to practice spending management through budgeting » acknowledge the need for financial discipline INTRODUCTION The previous chapter shed light on the concept of financial literacy and its importance. Continuing with this knowledge journey the first and foremost skill which one desire is cash management. At times people find that despite the availability of sufficient quantum of funds, one is still not able to meet the ends. This is so because one is failing to prioritize expenses. Cash management is not something in which you can expertise overnight. It is a long and ongoing process. Under this, one must be able to differentiate between the concept of need and want, learn the art of budgeting and follow a systematic approach to managing spending. The current chapter sheds light on such concepts and skills. NEED VS. WANT Needs are basic requirements that are necessary for survival, such as food, shelter, and clothing. Some examples of needs include food and water, shelter (a place to live), clothing to protect the body from the elements, medical care when ill or injured, etc. Wants are desires or things that we would like to have but are not essential for survival. 2.1— VV —— / PRODUCTS UNIT 1: FINANCIAL PLANNING AND FINANCIAL PR items such as expensive ; creationa such as *e clothin’ OF activities, s of wants include luxury Some example: on ‘ 5, re jewellery, electronics, such as smartphones or aa al such as going to the movies or a theme park, home pillows or artwork, etc. sr resource’, It's important to distinguish between needs and wants eee can help including time and money, are limited. Prioritizing needs over chased us allocate our resources more effectively. Both needs and wants oa ae er with money. At times people confuse their wants and needs and eee ecules in money on the things they don’t require or can be postponed ie aan them not having enough money for their needs. A budget can help P' figure out what is required and what is not. Difference between Need and Want | Components Needs Wants | Meaning | Needs are things required by a| Wants are the things which a | person in order to survive person buys in order to satisfy | his/her desires 7 | Necessity Needs are a necessity and very | Want is something which offers | crucial for survival comfort but is not a necessity | for survival | Satisfaction Satisfaction is achieved only when | Merely thinking about wants can the need is fulfilled offer satisfaction | Competition There is no competition in case | Wants are competitive in nature of needs. Each and every need is | and depending on the availability required to be fulfilled of funds the decision is made L among all Severity All needs are equally important | Different wants have different importance; thus, the choice is required to be made Deferment A need cannot be postponed Wants can be postponed Non-Fulfil- Failure to fulfil needs results at | Not fulfilling the wants can result | ment the end of life in social and mental distress Let us understand using some cases. Case-1: Riya and Mayank are a young couple in their mid-20s who have recent! gotten married. Riya has a job as a teacher and Mayank works in sales, They li in a small apartment and are trying to save money so they can eventually bre a house. Riya loves designer clothing and frequently shops at high-eng a Mayank enjoys going out to eat at expensive restaurants and trying ne oe beers. They both have student loan debt and are struggling to save money, aCH. 2 : SAVING AND SPENDING MANAGEMENT 23 Inthis case, Riya and Mayank need Clothing and dining out are want. and indulge in occasional luxuri and cut back on unnecessary sp Riya could shop at thrift store: to differentiate between their needs and wants. ‘S, not needs. While it is important to enjoy life les, they need to prioritize their financial goals ending. Instead of shopping at designer stores, 's or buy clothing from lower-priced retailers. Mayank could try home-brewing beer or cooking at home instead of going out to eat. By cutting back on wants and focusing on their needs, Riya and Mayank can save money and build a solid foundation for their future. Case-2: Kartik is a 50-year-old man who has been working in the same job for the past 30 years. He has a comfortable salary and owns a nice house in the suburbs. However, Kartik has a lot of consumer debt from credit card purchases and car loans. He has a habit of buying things he doesn’t need, like the latest gadgets and designer clothes. Kartik has also been neglecting his retirement savings and has not put much money towards them. In this case, needs to focus on his needs and prioritize saving for the future. Paying off consumer debt and building a retirement fund are needs that should take precedence over buying unnecessary luxury items. Kartik can work on cre- ating a budget and paying off his debt. He should also focus on increasing his retirement contributions, whether through his existing fund or other investment options. By prioritizing his needs and saving for the future, Kartik can create wealth and financial stability. ~— Case-3: Sonali is a single mother of two young children. She works as a nurse and is struggling to make ends meet. Sonali’s car recently broke down and she needs to buy a new one. She has a small amount of savings, but she is hesitant __ touse it because she is worried about having enough money for other expenses. In this case, buying a reliable car is a need for Sonali and her family. Transpor- tation is necessary for Sonali to get to work and provide for her family. While it may be tempting to save her savings for a rainy day, the need for a car is more pressing. Sonali can consider purchasing a used car or negotiating for a lower Price to save money. She can also look into financing options or government assistance programs to help with the cost. By prioritizing her needs and finding Ways to save money, Sonali can ensure that her family has the resources they need to thrive. Case-4: Tarun is a recent college graduate who has landed his dream job in the tech industry. He has a high salary and is excited to start his career. However, Tarun has a lot of student loan debt and is struggling to save money. He tends to spend money on expensive hobbies and trips. In this case, Tarun needs to focus on paying off his student loans and saving Money for the future. While it is important to enjoy life and pursue his passions, Tarun should consider finding lower-cost ways to do so. Instead of going on €xpensive trips, he could try travelling to less popular destinations or staying in budget accommodations. Tarun should also prioritize paying off.° 24 NIT 1; FINANCIAL PLANNING AND FINANCIAL PRODUCTS —_ SPENDING MANAGEMENT Spending management is the art of controlling di nproving the ways in which /her money with the intent to der ive maximum value/utility. ocess which requires constant monitoring and modifications | changes like an increase in income, increase in etc. Spending mana a person spends his It is a continuous pr" : ircumstantia depending on cit i : expenses, unexpected medical emergencies, Income: Income is the amount of funds which an individual eri a partic- i An individual can have passive income ane’ active income, een hing which is earned by putting in some effort like salary, ee ecgniceeiainrnty etc, Passive income is something which requires ra to no effort like interest on bank deposits, dividend income, ete. Nowadays it is advised to have multiple sources of income as the cost of living is getting higher and higher. Expense: Expense is the amount spent by an individual on goods, services or assets which provides some utility. These spending can be regular which are recurring in nature like weekly grocery bills, daily conveyance charges, etc., and irregular ie,, non-recurring like eating in a five-star restaurant, bi-annual health check-up, etc. Keeping track of all the expenses is one of the key requirements in efficient spending management. Steps in Spending Management Various steps to be followed by an individual for managing the spending: 1, Start with a Budget: The first and most important step to becoming financially disciplined is to make a budget. A budget is simply a plan for how you will use your money. It is a way to keep track of income and expenses and to make sure you are spending within your means. A budget allows you to see where your money is going and how much you can save. It can also help you identify areas where you can cut back and Save more money. a Set Goals: Setting financial goals is an im pline, Goals can be short-term, like savin like retirement. Setting goals helps you fo: and helps you stay on track. Be sure tos . Track Spendin; becoming finan Portant part of financial disci- ig for a vacation, or long-term, cus on what is important to you et realistic and achievable goals, B: Tracking your Spending is another important step to secon Vo a, iseiplined. Tracking your spending helps you identify eae e overspending and where you can make cuts, jf also you stay on top of bills and other payments. 4. Automate Your Savin; tive way to Start savin, even thinking about it w igs: Automating your savings is an easy ang ig: Automating your savings helps you save w, ~ the money is transferred to your savings a €ffec- ithout “countCH. 2 : SAVING AND SPENDING MANAGEMENT. 2.5 automatically each month, It can help you stay on track and reach your financial goals faster. . Save for Emergencies: Emergencies can happen anytime and it is im- portant to be prepared. Having an emergency fund can help you cover unexpected expenses and keep you from going into debt. The aim should be to save at least six months’ worth of expenses in case of an emergency. . Make Smart Investments: Investing your money is a great way to grow your wealth over time. However, it is important to make smart invest- ments. Research potential investments carefully and speak to a financial advisor if needed. Also, be sure to diversify your investments to spread out the risk. . Live Within Your Means: Living within your means is an important part of financial discipline. This means spending less than you earn and avoiding debt. Try to avoid lifestyle inflation where you increase your spending as your income increases, 8. Avoid Impulse Buying: Impulse buying can be a major drain on your finances. To avoid impulse buying, create a list of things you need before you go shopping and stick to it. It can also help to wait 24 hours before purchasing so you can consider if you need the item or not. 9. Stay Organized: Organization can help you to stay on top of your finances and ensures that you don’t miss any payments or bills on the due date. Create a system for managing your finances and keeping track of bills and payments. 10. Get Professional Help: Finally, if you need help with managing your finances, don’t be afraid to seek professional help. A financial planner or accountant can help you devise a plan for reaching your financial goals and provide advice on investments and other areas. HOW TO MANAGE SPENDING: BUDGETING A budget is a blueprint of all your income and expenses. It lists out all the Sources of income, all the needs which are required to be paid for and the wants that you intend to fulfil. The lists help you to make sure that you jump to your wants only when all the needs are provided for. The wants will have to wait if the funds are sufficient enough only to cover needs. Let us understand with a hypothetical scenario. Making a plan for how much money you will have to spend, manage, and save is called budgeting. Setting goals, keeping track of expenses, and keeping tabs On spending are all part of this monthly strategy. It is an effective instrument assisting people in maintaining their financial life in order and achieving their financial goals.2.6 UNIT 1; FINANCIAL PLANNING AND FINANCIAL PRopy . UCTS A person's hypothetical monthly budget to manage his igen nae something like this: S_woul Income: 2 30,000 in salary % 1,000 in investment income % 31,000 in total income Expenses: % 3,000 in utilities, € 7,000 in rent Buying food: % 8,000 Internet/Telephone: % 500 Vehicle Loan EMI: % 6,000 Gas: % 2,000 % 2,500 for entertainment % 29,000 in total expenses. Savings: % 2,000 (31,000 - 29,000) in total monthly savings Finding one's income is the first step in making a budget. In this example, the person's income is comprised of a = 30,000 salary and = 1,000 in investment income, totalling = 31,000. Making a list of one’s spending is the next stage. Both fixed costs like rent and utilities and variable costs like food and entertainment should be on this list. The final cost stands at % 29,000. The person in this scenario has a total monthly savings of & 2,000 after deduct- ing all expenses from all income. This sum can be used to increase savings or reduce debt. For people to take charge of their money and achieve their financial goals, budgeting is a crucial tool. Maintaining a budget and keeping track of income and expenses are required. Individuals may make sure they are making wise financial decisions and remaining on track to achieve their i i goals by de a budget and keeping track of their expenses. 7 Aeveloping SAVING Savings are the portion of income left aside by people for future contingengj, expenditures. As Savings are turned into an investment, they hold an inners place for economic growth. Cash has no return, but putting money into bs int or investing it will enable one to earn a return on it. Moreover, banks co anks the deposits will be able to lend more. Leading to more money circulation pane investments and more growth (money multiplier process). » More aCH. 2 : SAVING AND SPENDING MANAGEMENT. 27 money saved can act as an emergency fund as i e it is highly liquid i.e., can be me Mithdrawn when needed, ghly liq ea nce, in esse . : ‘ . 1, Savings, if deposited, turn into profitable investments when channelized via banks. 2, Dependency on foreign funds reduces, i 3, Long-term sustainable investments lead to sustainable growth. ne most popular means of saving money is through bank deposits. The types ofbank accounts in India can be primarily classified into three major categories, which are as follows: 4. Savings Accounts These are the types of accounts that give a basic percentage of interest rate and are meant for households and individuals to inculcate the ‘habit of saving. pifferent banks offer different types of rates on the saving account depending upon the applicants. 2. Current Accounts Current accounts are those types of accounts which offer no interest rate but provide useful services with the help of a business therefore such types of ac- counts are opened by businessmen. The current account provides facilities such as no limit on withdrawal and deposit, a cheque facility, and various types of transactional rebates and net banking facilities. 3, Fixed Deposits Fixed deposits offer the highest interest rate among any type of account avail- able in the category. Fixed deposits are made for investment over a longer-term horizon and they generally have lock-in periods so that the depositor cannot Withdraw his/her money prior to a specified and agreed date. Fixed deposits also include types of accounts such as recurring deposits which require the de- Positor to deposit a certain pre-agreed amount at a pre-specified time interval f A Ora longer-term horizon to access the higher interest rate as compared to the Savings account, FINANCIAL DISCIPLINE _ a Financia) as . ; io discipline means how well one is able to adhere to his/her spending ms and guidelines. Financial discipline doesn't appear magically. One has to ard to control their fickle mind and stick to their budget and spending Dlan, . Sto avoid Tegret afterwards.—_— . OT oOouLL—_—_—_— UNIT 1 FINANCIAL PLANNING AND FINANCIAL PRODUCTS An individual can attain financial discipline by educating oneself about the tips and tricks of budgeting and spending management, developing a habit (not just a one-time thing) and finally taking accountability for the actions. A financially disciplined individual is better off at protecting oneself from debt traps. An individual can become financially disciplined with money in life through: 1. Define Your Financial Goals: The first step in becoming financially disciplined is to set clear, attainable goals. Determine what you want to achieve financially and why. Consider both short-term and long-term goals. Make sure they are measurable and time-bound. nN Track Your Spending: You must know where your money is going in order to stay on top of your finances. Keep track of your spending to identify patterns and areas of improvement. Use a budgeting app or spreadsheet to log all of your expenses. 3. Create A Realistic Budget: A budget is an essential tool for becoming financially disciplined. It helps you to plan for your income and expenses. Create a budget that works for your lifestyle and stick to it. . Automate Your Finances: Automation is a great way to stay disciplined with your finances. Set up automatic payments for bills and regular trans- fers into a savings account. This will take the guesswork out of managing your money. 5. Eliminate Financial Temptations: If you’re surrounded by financial temptations, it will be difficult to stay disciplined with your money. Find ways to reduce temptation and stick to your financial goals. . Make Saving a Priority: Saving is an important part of financial disci- pline. Make sure you set aside a portion of your income each month for savings. Consider setting up a separate savings account or investing in a retirement account. . Find Ways to Cut Costs: Look for ways to save money on daily expenses. Make adjustments to your budget and consider switching to lower-cost providers for necessary services. . Seek Professional Advice: If you’re facing trouble in managing your costs, go for professional help. A financial advisor can help you create an appropriate plan to meet your financial goals timely. . Practice Patience: Becoming financially disciplined takes time. Dont get discouraged if you don’t see immediate results. Remain patient a" continue to work towards your goals. 10. Reward Yourself: Celebrate your successes and reward yourself for making progress towards your financial goals. This will help to keeP 2 motivated and on track.CH. 2: 2: SAVING AND SPENDING MANAGEMENT 29 AY Reiley Ty 1, Differentiate between need and want. 2, What do you mean by spending management? Give steps in spending management, 3, What do you mean by financial discipline? How can one practice financial discipline? 4, What is budgeting? (Noa oy Va aS 1, Prepare a monthly budget for your expenses. Keep track of them for a while say 6 months. During this time period practice financial discipline. Compare if you were able to tame your spending or not. Classify your expenses into needs and wants and see how much you are able to save if you are able to control your wants.Financial Goals and > Planning LEARNING OUTCOMES The learning from this chapter will enable students > get familiarized with the financial goals Popular among the public > understand how to prioritize and set financial goals > learn the concept of financial Planning and its need/importance > become aware of the steps to follow in financial Planning INTRODUCTION We can all agree that the ultimate 8oal of financial literacy is to attain the re- quired skills to prepare a sound financial plan, We all have various goals which we want to achieve in life like funds for higher education, owning house Property, owning a vehicle, children’s marriage, retirement, etc. Without Proper financial skills and knowledge, it is next to impossible to achieve all these goals. So, in this, we will look at the different types of financial goals and the steps needs ‘o attain these goals, FINANCIAL GOALS _ Financial Goals are the targets one intends to achieve through money manage- Ment. Setting financial goals can help in attaining financial discipline. They assist 'n encouraging savings and making conscious investment decisions. Some of the popular financial goals are given below: ‘Make a budget and live by it: A certified financial planner and renowned author Ric Edelman once said “Budgets are focused on debts and expenses and body got rich by focusing on their debts,” and “You get wealthy by focusing ce JOUr assets and your income.” However, many experts agree that when it “mes to financial planning budgeting has a lot to offer. They clearly define 3.1Fl NCIAL PRODUCTS. 3.2 UNIT LS FINANCIAL PLANNING AND FINA i in managing the amount of income and expenses of a household which helps in , savings and investments, - ing off credit card debt is 7 Pay off credit card debt: Being diligent in eee but it is a bane as ‘ very crucial. Credit cards are a great financial ae elt ease aathe: well if not Managed properly. You never know, one de! bt trap. In the words of another and after some time you realize are under a del s about not using the Wohlwend, “Once you pay them off, you should be consciou pe eordecions credit card as much. The whole system enables people to ma , hat’s happening Once you get caught up in that culture, you don't even know wi until you add it all up”. i job Save an emergency fund: 6 months’ worth of expenses a ant cee market is very fragile and you never know when medical bills 8) o emergency funds are essential. Save for retirement: Lusardi e need to make tion. And it long-term d: oa It mphasised retirement saving by saying “We a saving, particularly retirement saving as exciting as consump- is exciting when you consider it gives us the capacity to reach our reams. People just need to see it that way”. Live below your means: This doe: 'S not involve rocket science to understand. is simple logic. If you spend m ore than you earn, you will incur debt and if your spending is within your earnings, you can save for your future. Develop skills to improve your incoi ant and if those spendings are directed exponential. Thus, the world has a lo me: Spending on oneself is very import- towards skill development is benefit is do keep targets on up skilling yourself and you will realize t of opportunities to offer. Save for your children’s education: The importance of college education can be realized from the fact that college graduates earn 66 per cent More than just high school graduates, The rising college tuition has mandated People to plan for their children’s eq cation well in advance, @ Save a down Payment for a home Owin; de a house proper f every individual but the amount of in i? es ane een ’ overnight. Thus, v Quires cannot be gathered rt Planning at the earli the down Payment, the More fi of the loan. or i i improve your thier The Credit score of an individual is like an as- - er creditworthiness. A person with a high credit score ans at lower Interest rates which j should be to Maintain high cre ; is always h i A ditworthiness. aS As Tightly saiq by Annamaria Sor who also is One of t] bottom line is eve rom line can do their financial future” ee gton University profes- bi and “Make a del t management “The €veryone Should q 5 plan, then follow ° more to plan for that plan” ili. experts onCH. 3: FINANCIAL GOALS AND PLANNING oo HOW TO ACHIEVE YOUR FINANCIAL GOALS Making a plan by prioritizing your goals is the most efficient way to reach financial goals. When you analyse your goals, you will discover that some might take you some time to reach, while others do not so much. Thus, based on the time span, the financial goals are classified into 3 categories: (A) Short-term Goals Short-term goals are financial goals with a narrow scope and limited time hori- zon. It includes purchasing household electronics, furniture, house renovation, vacation spending etc. Moreover, the more important short-term goal is getting a grip on your spending, starting to practice budgeting, avoiding short-term debt defaults, setting a minimum limit of regular savings and starting building your emergency fund as soon as possible. Short-term goals require you to question your spending and ask yourself “is it really that necessary?” If you are able to answer them honestly you are on the right path towards financial peace and freedom. This all might sound daunting to perform on your own but can always go to financial advisors for assistance. (B) Mid-term Goals The tendency to weight financial plans around the near and long-term goals has been called the “barbell” approach. However, due considerations need to be given to mid-term goals which take between 3 to 10 years to fulfil. Some examples of mid-term goals are a down payment on a house, paying off a study loan, international vacation, starting a business, etc. As the time horizon increases, so does the money needed. Thus, an important mid-term goal is to generate multiple streams of income. In today’s time where livelihood is getting expensive day by day, one cannot survive just with active income, you need to develop a passive income stream as well through part-time freelancing work or income-generating investments. Your financial counsellor can guide you towards your midterm strategy. (C) Long-term Goals Your long-term goals are directed towards being done with your responsibili- ties and lining a comfortable and stress-free life. Thus, some popular long-term Qoals are children’s education, children’s marriage and comfortable retirement. These goals are realised between 20 to 40 years. These goals require disciplined investing because they cannot be compromised. The goal-setting process includes decisions regarding what goals you want to attain; determining the quantum of funds you need; and estimating the time Period required to reach those goals.Ww 34 UNIT 1: FINANCIAL PLANNING AND FINANCIAL PRODUCTS ATTRIBUTES OF SOUND FINANCIAL GOALS: SMART S stands for Specific What do you want to achieve? One should start by answering this question, The goals should be clearly outlined and how they can be achieved must be clearly stated. This also helps in keeping oneself motivated to stay on the right track. Ambiguity about one’s goals can lead to confusion and chaos and delays in achieving them. For example, if you aim to save for higher education of children you must an- swer the following questions. How much do I need for this goal? How long do I have to collect the funds for this goal? How am I going to collect funds for this goal? M stands for Measurable The essence of this attribute can be phrased as “if you can see it, you can do it’. By measurable, we mean that one should be able to gauge his/her progress during the courses of fulfilment. This will help in keeping track of the current efforts and if any revisions are required in the efforts in the future. One can do so by putting small yearly milestones in the overall long-term goal to keep oneself in check. For example, one can use a retirement calculator available online to gauge the process and see how much more is required to attain the goal. Astands for Achievable Wishful thinking can result in disappointment and mental distress. Financial goals are indeed challenging, but they should not be impossible to attain. One should be realistic about one’s goals and should perform thorough research regarding their attainability. For example, currently, you are 28 with an annual income of % 7,50,000. You aim to retire at the age of 60 with a retirement corpus of % 30,000,000. You have to ask yourself in light of current finances will you be able to achieve it or is it just wishful thinking? R stands for Relevant By relevance, we mean that your goals should not be arbitrary. They should be personal to you and must hold some significance to you. The path to achieving financial goals can be very tough and daunting and if you set a goal which does not hold any significance to you, the journey will feel like a burden and you will not enjoy it.CH. 3: FINANCIAL GOALS AND PLANNING 35 example, when planning your retirement as yourself: Fo! will my family expenses in the future affect my goal? Are there any activities or hobbies of mine which can deter me from attaining this goal? How badly do | need to achieve it in the required time period? Can it be com- promised or delayed? T stands for Timely/Time-Bound There are a few popular phrases like “You have all the time in the world” or ‘Life is too long to fret about things”. They sound pretty nice and carefree. Right? But, being carefree can cost you your future. The timeliness of the financial goals ensures that you are serious about your goals and can set priorities. Thus, putting a time stamp on your goals is important. It also gives you a realistic deadline which can help is guiding the quantum of your efforts to achieve them. This can be done by giving oneself regular timely deadlines. FINANCIAL PLANNING Financial planning means developing a personal roadmap for your financial well-being. The outcome of the whole planning process is a path which needs to be followed to attain all the financial goals in the light of external hindrances like inflation, taxes, etc. It means systematically planning your finances in order to achieve your financial goals within the defined timeline. Financial planning process The financial planning process involves several steps that an individual can follow to achieve their financial goals. Step 1: Define your financial goals ‘The first step in the financial planning process is to define your financial goals. This involves understanding your current financial situation and determining what you want to achieve in the short-term, medium-term, and long-term. Some common financial goals include saving for retirement, purchasing a home, paying off debt, and saving for a child’s education. Step 2: Assess your current financial situation The next step is to assess your current financial situation. This involves review- 'ng your income, expenses, assets, and liabilities. By understanding your current financial situation, you can identify areas where you may need to make changes in order to reach your financial goals.3.6 UNIT 1 : FINANCIAL PLANNING AND FINANCIAL PRODUCTS Step 3: Create a budget Once you have a clear understanding of your financial situation, you can create a budget. A budget is a plan that outlines how you will allocate your income and expenses in order to meet your financial goals. It is important to track your spending and stick to your budget to achieve your financial goals. Step 4: Develop a financial plan After you have defined your financial 8oals and assessed your Current financial situation, you can develop a financial plan. A financial plan is a Toadmap that outlines the steps you need to take to achieve your financial 8oals. It should include a timeline for achieving each goal, as well as a strategy for how you will achieve them. Step 5: Implement your financial plan Once you have developed a financial plan, it is important to implement it. This may involve making changes to your spending habits, investing your savings, or making other financial decisions to help you reach your goals, Step 6: Monitor and review your progress It is important to regularly review and monitor your financial plan to ensure that you are on the right track to attain your financial goals. This may involve reviewing your budget, adjusting your financial plan as needed, and making any necessary changes to your financial strategy. By following these steps, you can create a solid financial plan that will help you achieve all your crucial financial goals. It is important to be Proactive and disciplined in managing your finances, as this will help you achieve financial stability and security in the long term. Practical benefits to financial planning Financial planning helps you to: ¢@ Increase your Saving: It is not impossible to save money without a financial plan will it be efficient that is something to be thought about. When you make a financial plan you become aware of your income and expenses which will help you in keeping track of them and assist in prac- tising cost Consciousness, which will automatically help you in increasing your savings in long run. © Enjoy a better standard of living: It is assumed that high monthly bills and EMI repayments hinder your living standards. It is not true. A well-developed financial Plan will help you to honour your obligations on time, meet all your expenses and still enjoy a comfortable and stress-free life.CH. 3 : FINANCIAL GOALS AND PLANNING 3.7 o Be prepared for emergencies: The creation of an emergency /contingency fund is a must. It is the first step towards a stress and anxiety-free life. Unexpected financial distress can affect your mental health, which in turn affects your performance, which ultimately results in a loss of income stream. Thus, it is advised to maintain a fund equivalent to 6 months of your expenses, Attain peace of mind: A person practising financial planning is able to manage his/her finances properly and have a peaceful mind. Sometimes you might hit a rock bottom, but you should not be discouraged because ultimately you will reach your goal if you stay disciplined in the path of your goals. It might take you some time, but you will reach the stage of financial peace. Need for financial planning The financial plan serves as a guide as you go through life’s journey. It helps you to manage your income, expenses, and investments in such a way that you can manage your finances and achieve your goals. You need to have enough money to achieve your goals and desires. Personal finances can help us increase our cash flow. Keeping track of our ex- penses and usage patterns enables us to increase our revenue. Careful planning, careful spending, and careful saving ensure that we do not lose the money we have worked hard for. A well-defined plan ensures that you do not deviate from them. It reduces the mental stress and anxiety related to financial well-being. If the goals are well defined in the planning process, one can customize the strategies in order to attain them. We all agree that everyone thrives when appreciated for one achievement. As you attain your goals in your life, it will give you a sense of achievement which will further act as a motivator to stay motivated for future goals. Personal finances include concepts related to money management, savings and investment. It includes banking, budgeting, debt, investment, insurance, retire- ment planning, and tax planning. REVIEW QUESTIONS 1, What do you mean by financial goals? List out some of the commonly identified financial goals. 2. Explain different types of financial goals. 3. What are the attributes of a sound financial goal?3.8 UNIT 1: FINANCIAL PLANNING AND FINANCIAL PRODUCTS 4. What is financial planning? Mention the steps in financial planning. 5. What is the need and benefits of financial planning? 1. After learning in detail about financial goals and financial planning, you were keen to share your knowledge with your elder brothers/sisters. While taking with you they disclosed that they never thought about developing a formal financial plan for their life goals. They asked you for your help. You are required to help them to analyze (using SMART) and set their financial goals and develop a well-structured financial plan. Document the whole process. ——eet |The learning from this chapter will enable students > gain an understanding of the concept of the time value of money » learn how to choose between present cash inflow or cash inflow in the future : > understand the power of compounding » get familiarized with the application of the time value of money in real life INTRODUCTION We all have gone grocery shopping with our mother in the local markets. Right? So, we recall the same grocery like potatoes which we used to buy for = 5/kg 15 years back is now sold for = 30/kg. Have you thought of the reason why is it so? What happened in these 15 years? The answer is the time value of money. In any financial decision, the time value of money holds immense importance. In this chapter, we will understand this concept, how to calculate it and why? TIME VALUE OF MONEY Simply stating, the time value of money means that the value of a rupee today will not be equal to the value of a rupee tomorrow. The purchases you make with the specific amount of money will not be sufficient to make the same quantum of purchases in the future. If you want to derive the same utility in the future you have to spend more. Thus, with time the money loses its worth. 4142 UNIT 1 : FINANCIAL PLANNING AND FINANCIAL PRODUCTS Relevance of Time Value of Money As already stated, money loses its value with time. One of the key reasons is inflation. Therefore, people prefer to receive money as soon as possible and try to delay their Payments as much as possible. Other reasons are given below: Uncertainty in the future: If you are presented with two options. One is to receive money today and the other is to receive money after 2 years with a 10 per cent appreciation. What will be your choice? Along with determining whether this 10% appreciation will be able to cover the value erosion, your answer will also depend on how certain you are that you will receive this amount after 2 years. @ Preference for current consumption: Anyone who is more concerned about current or immediate consumptions will mostly go for immediate cash inflows. Therefore, your decision between current or future inflows will be based on how much your consumptions can be delayed and how well they fit with your inflow’s timeline. ¢ Opportunity for reinvestment: Another reason for preferring current income is the opportunities available for their investment. Here, you have to compare if there is any investment opportunity available which can provide better returns that the return which is offered to accept future payment. For example, you have two options. One is to receive = 1,000 today and the other is to receive % 1,050 after one year. There is an in- vestment opportunity which offers an annual return of 10%. Now in light of the existing opportunity, what will be your choice? The answer will be option 1. If you accept after 1 year you only receive = 50 appreciation. However, if you go for the current receipt and invest it you will receive % 100 appreciation. It is safe to say that knowledge about the time value of money is relevant to make an informed decision. It helps you understand the worth of your money thereby guiding you to derive the most out of it. TVM GLOSSARY Annuity An annuity refers to the regular cash flow of a fixed amount at equal intervals for a specific time period. A lease requiring payment of % 20,000 per month for a period of 50 years is an example of an annuity. It is a “600 months period, = 20,000 annuity”. The identical nature of cash flows in terms of amount and time gap in frequency of payment is a necessary condition to call it an annuity. There are two types of annuities based on the time of payment:CH. 4: TIME VALUE OF MONEY os ¢ Regular/Ordinary Annuity - The first payment is made at the end of the year (at period 1), ° ne Due - The first payment is made in the beginning only (at period Compound Interest Compound interest is a situation where the interest is calculated not only on the principal amount but also on the interest earned throughout the years. This is a concept of exponential growth of money. Compounding Frequency Compounding frequency means how frequently the interest is calculated and credited to the account. As the interest is credited it becomes principal in the immediate next period. The compounding frequency plays a crucial role in determining the exponential growth of money. The higher the frequency, the higher the growth of money. For example, the future value of % 10,000 invested at the rate of 10% per annum for a period of 3 years compounded annually is 7 13,310, compounded bi-annually is % 13,400, compounded quarterly is % 13,449 and compounded monthly is = 13,481. Discount Rate Adiscount rate is a rate which is used to derive present value from future value. The process is known as discounting because the present value is less than the future value in absolute terms. Future Value Future value refers to the value of money which is expected to occur at some future date. For example, the future value of @ 1,000 invested today for a period of 2 years at the rate of 15% per annum compounded annually is @ 1,322. This means that after 2 years this = 1,000 is equal to % 1,322. So, in literal transla- tion, future value means “what will it be worth at some future point in time?” Number of Periods It is the time period for which the compounding and discounting are done to arrive at future value or present value respectively. For example, if compounding is done annually for 5 years then the number of periods is 5. If compounding is done quarterly for 5 years, then the number of periods is 20 (5 years * 4 quarters).4.4 UNIT 1; FINANCIAL PLANNING AND FINANCIAL PRODUCTS Perpetuity Perpetuity is like an annuity for an infinite time period. It is also known as perpetual annuity. . Present Value Present value is today’s values of the cash flows which will be received in the future. It is the amount that an individual is willing to pay at present in order to receive certain cash flows in the future. Literally translated, present value means “what is it worth right now?” The present value of = 10,000 to be re. ceived after 2 years having a rate of interest of 10% is % 8,264. This means that you are willing to pay today & 8,264 in order to receive 10,000 after 2 years, COMPOUNDING Compounding is a strategy where the return on an asset or investment is rein- vested in order to generate more income. In simple words, it means “generating returns from returns in the future”. The value derived through the compound process is known as future value. Power of Compounding Let us understand the power of compounding with an example. Mr Sahil decided to invest % 1,00,000 every year for a period of 5 years. The rate of return is 10% per annum. He has two options. Option 1: Withdraw interest earned as and when they are earned. Option 2: Reinvest the interest earned in the same investment option. Now, in option 1 Mr Sahil will be earning a return of % 50,000 (1,00,000 * 10% * 5S) during the 5 years. Under Option the calculation is as follows: | Year Opening Investment Interest Closing balance balance 1 = 1,00,000 10,000 1,10,000 2 1,10,000 1,00,000 21,000 2,31,000 Sia 2,31,000 1,00,000 33,100 3,64,100 | 4 3,64,100 1,00,000 46,410 5,10,510 5 5,10,510 1,00,000 61,051 671,561 __| 5,00,000 1,71,561 I From this table, you can see that in principle he invested only & 5,00,000 and its value appreciated to & 6,71,561 after 5 years offering a total return off 1,71,561