How Not To Save

By now you must have decided how to implement the 70-10-10-10 formula or a suitable variation. Just as it is necessary to know what to do with your income, it is equally important to have an idea of what not to do. And one thing that is clear in my mind is not to use Savings Account (also known as Checking Account in some countries) for saving. Savings account does not save you anything. It has the lowest interest rate (some 3 - 4%per annum) and until recently had the most cockeyed interest computation scheme.

The interest was computed on a monthly basis on the lowest balance of that month between the days 11th to the end of the month.

Example:

Date----------Balance
1st Jan ----- Rs. 50,000
7th Jan ----- Rs. 1,000
10th Jan --- Rs. 100,000
15th Jan ---- Rs. 2,000
25th Jan ---- Rs. 500,000

In this case, the monthly interest will be computed on Rs. 2000.

This has thankfully now changed. The interest is now computed on a daily basis on the minimum amount per day. See here.

That said, even this does not make a Savings Account very attractive. Savings account should only be used for parking your money temporarily. As a rule of thumb, I would recommend that at any given time no more than 1.5 months salary be parked in such an account. With intelligent use of credit card (yes, credit cards can be used intelligently) the maximum amount to be parked in a Savings Account can be brought down drastically.

Escape the Curse of Credit Card

In my last post I showed you how deadly the credit card can be. Once you get into the credit cycle, you end up paying much more than you bargained for.

Does that mean you should throw away your credit card?
The answer to that is very simple: No you should not. Rather you need to use it with wisdom.

Here are two ways to escape the curse of the credit card.

1) Keep a track of what your expenditure. I always assume that the money paid by credit card belongs to this month's expenditure. It is easy to keep a track now-a-days. Banks let you see your credit card statements whenever you wish to - not just at the end of a billing cycle. At least, my bank, Standard Chartered, has that facility. Regular checks on your credit card will also help you look out for any credit card frauds.

2) Do not use the credit facility of the Credit Card. Pay your entire amount every month. One way to force this on yourself is to give a standing instruction to your bank to pay off 100% of the amount.

Of course, you could also use the Ice Glass Method

The Curse of The Credit Card

Credit card is a potential drain on your earnings. It doesn't seem so, but it is. You tend to spend more when you shop with a credit card. The removal of actual cash passing your hands to another desensitizes you. And all the small purchases add up when the credit card bill comes knocking you door. But there is something more pernicious in credit cards. And that is the minimum payment clause. Why do you think the bank / credit card company allows you to pay only a part of the total. It is not that they love you. It is because it gives them more revenue.

Let's see how it works.

Assume you have made a purchase of Rs. 100. You are allowed to make a minimum payment of 10%. You have to pay for the outstanding amount at 2.5% per month (yeah, it is per month). But there is another twist here. The interest free period disappears when you make a part payment. So you actually pay interest on the Rs. 90 from the day you make a purchase. Suppose you decide to pay off the whole amount in 10 months, you end up paying Rs 11.25 extra. Not much you say? I would loath to pay Rs. 11.25 on every Rs. 100.

But consider this. You not only pay 2.5% on the amount outstanding for the original purchase, you also pay 2.5% on any purchase you make in the payoff duration - even if you pay off the entire amount for the purchase within the billing cycle.

Let us take a simple example. This is your purchase and payment pattern

Month--Payment-----Outstanding-------Purchases------Interest
------------------------------------------------------------
Jan----Rs.100
Feb----Rs.10---------Rs.90------------Rs.1000--------Rs.2.25
Mar----Rs.1090-------Rs 0-------------Rs 0-----------Rs.27.25

Basically, you end up paying for the Rs 1000 for the month of February even though you paid it off without carrying anything forward.
Deadly, isn't it?

By the way, 2.5% per month does not work out to be 30% per annum. It works out to be approximately 34.5%. You might as well take a consumer loan from the bank at 12.5% and pay off the outstanding amount on credit card.

Before you take a home loan

In my post yesterday, I talked about reducing your debt. This post is focused totally on reducing your debt created by your home loan. Having a roof over your head is a middle-class dream (actually everybody's dream - who wants to shuttle from one house to another every 11 months).

Here are a few aspects that you need to consider before you take a home loan:

1) Do not take loan from the first bank you approaches you. Talk to as many banks as you wish to. And let the banks know that you are talking to many banks.

2) It is not necessary to take loan from the same bank as your friend did.

3) Negotiate, negotiate, negotiate. Every aspect is negotiable.

4) If you tell one bank that the other bank is giving you the loan at a lower Equated Monthly Installments (EMI), the first bank will reduce its EMI to match. (Hint: Ask the first bank to better the offer; not just match.)

5) Floating interest rates are always better than the fixed loans. Remember that the fixed loan is not really fixed for life. If there is a huge upward difference between what was offered and what it is now, banks are within their right to hike your interest rate upwards. They will never reduce it downwards though.

6) Don't bother about interest rate. Instead find out what will be your EMI. There are many EMI calculators available online. Check out your EMI from that calculator and compare with what the banker has to say.

7) Always go for loans where you can make advance payments - in part or in full - without penalty. If all the banks offer pre-closure of loans with penalty, find out the penalty amount. Get this in writing.

8) Your insurance company, such as LIC of India, may also offer loans that also covers your death or disability. This is a good option, if you are already not covered adequately. There is a huge advantage in this. In case of your untimely death - God/Nature forbid - your dependents will no longer have to repay the loan.

9) Most of the time, you will be talking to an agent of the bank. The agent will promise you the earth. The bank may not follow it up. Maintain a note book and note down what each agent has promised you. When the bank gives you the loan letter check if all that was promised is included in the letter.

10) Do not burden yourself with the maximum offered home loan. Take on as less as possible. See Reduce your debt

Do you have some tips that I missed out?
Please leave a comment.

I will cover the "after" part of the home loan in my next post. Till then take care of your investments and your family.

The magic of interest compounded

There is just one golden rule when it comes to becoming rich. And that is ...

You should earn money even when you are not present.

So that rules out jobs.
Or even business where you need to be present all times.

Building a business where you employ clever employees is definitely a very big yes.
Investments in property, shares, mutual funds are a yes.
And surprise, surprise, monetized blogs (such as this one) are also a yes. At least for some (No! Not me! Not yet!)

The trick is to start early.
Reason: You have sufficient time to recover from setbacks - there will be setbacks, guaranteed. Youth is not risk averse. So that helps.

More importantly, the real benefit of compound interest kicks in.

How much do you think you get if you invest merely Rs. 2000 per year for 25 years that returns you 10% compounded annually. It is Rs. 2,16,363 ( more than 4 times)

You are risk averse?
You would like to put the money in a recurring deposit bank scheme that gives you just 5% returns compounded. In 25 years your money will become Rs. 1,00,227 (a shade over double)

But you should have 25 years with you. So don't start at 40. Start when you are 25 years old.

Impact of upbrining

I am an anti-thesis of Robert Kiyosaki, the author of Rich Dad, Poor Dad.

Reading Rich Dad, Poor Dad is thrilling. It is so well written that you start believing that you also can become rich. So what of me?

I have serialized the mistakes I made that perhaps has prevented me from becoming rich.

Some of you will identify with me: to them I would advise not to follow me.
Others will take a lesson from my shortcomings.
And by bringing myfear out in the open, I will change, ahem!

Basically, what I trying to do is introspecting into why I could not break out.

My father came from a huge family. He had 11 brothers and 3 sisters (Big family! What fun! In contrast I am single child.)

I grandfather was a lawyer in the town of Dhanbad.
I am told that he detested telling lies. So, one fine day, he decided he will stop practising law.
By then his eldest son started working (as a lawyer!!) but the overall income fell.
So the living standard suffered. This was pre-independent India.

My father left home at 16 to join the Indian Air Force (IAF). He was 6 ft and had - others have told me - a V-shaped body.

Someone once challenged him to a boxing bout and beat the hell out of him.
He resolved to take up boxing.
He went on to become the Air Force Boxing champions in various weight category.
He became known as 'Boxer Mukherjee'.

His boxing career ended after he married. My mother says that my father had near zero bank balance when she got married to my father.

In other words, he enjoyed his life as a bachelor. Boxing and enjoying life!
Mother then took charge of the household. She started saving pennies. This was early sixties. There was not much scope of investments in India.

Savings was all that was possible. She saved enough. Insured father's life. The insurance matured before father's death and with that money we purchased 'colour' TV and refrigerator.

This was when I reached college.
My parents managed to build a house from the savings and loan.
They managed to get me through school and college education.
And when father died in 1986 she did not have to ask money from anybody.
I am very proud of my parents.

My childhood has been a happy childhood. I was never denied any request.
But at the same time we never splurged. And we never went beyond budget.
People in Airforce cannot be called poor. But they are not rich either.
And we always saved. Banking was something that I learned fairly early.

So saving money is embedded somewhere in my brain.
Investment is risky, losing money is no fun.
Future is uncertain, so save money.

Over the years I have found it very difficult to tear myself away from the fear that arises from losing money.
Today, perhaps, I can afford risky investments.
However, most of my investments go into relatively safe instruments.

So what is Lesson #1.

To become rich you need to reformat your memory.
My parents did what they could do best according to their circumstances.
I should have done / should do what I can do best according to my circumstances.

Therefore, DO NOT LET YOUR PAST DICTATE YOUR FUTURE.

Wait for my next post for Lesson #2.