It was a Saturday morning. Since Pareshbabu had a day off from school, he offered to spend the whole day with Arvind and Vimla and complete his extended lesson in financial planning.
“Today, I’m going to finally tell you how you can plan your trip to Dubai,” said Pareshbabu, to the smiling couple. By now, they were finding his lessons so interesting, the trip to Dubai seemed to be simply an excuse to learn more from him about how to live a better financial life.
“Now that you know all about saving, investing and borrowing money, it’s time to put all the pieces together and get a picture of how to manage your money,” he began. “Today, we’ll spend the day learning how managing your money properly can help you meet your goals in life.”
“Managing money sounds like a magical exercise...what does it actually involve?” asked Vimla.
“It involves everything from budgeting and goal setting to spending, saving, investing and insuring and finally leaving a will for your near and dear ones,” he replied with a laugh.
“Please slow down professor,” she said quickly. “We want to know all about these things. After all, we have to translate them into actions, right?”
“Pareshbabu, I understand broadly what you mentioned about money management...how it means planning our spending, saving and investing...but where am I going wrong? I do all or at least most of these things too...”
“You certainly do, Arvind. But there’s something important missing...you are driving a car without a roadmap and more importantly, without a destination!!”
Both Vimla and Arvind have a good laugh. “I get what you mean. I do sometimes feel that I am going round in circles too...”“That’s the difference between cash management and financial management!!”
Pareshbabu explains the difference between cash management and financial management:
Most people earn money and then spend it paying off various bills and meeting day to day expenses – grocery bills, electricity bills, children’s school fees, buying vegetables and fruits, etc. They also have other one-time expenses to meet – fixing a leaking roof, buying medicines for grandmother when she falls ill, going to the cinema or mela with family, etc. Then at the end of it all, if anything is still left over before the next lot of income comes in, they may save it and even invest. Once in a way, if they have to purchase something large – like a fridge or a new television, they may borrow money to buy it or break some investment and spend the money on it.
There is nothing very wrong with this way of managing cash. But when you are faced with a bigger dream – like sending your child to a very good college in the city or paying for a big wedding for your daughter or going to Dubai, perhaps, what can you do? You have to either let the dream remain a dream or borrow large sums of money and turn your life into a nightmare!
Now, if you plan for your dreams in advance and save and invest for them, you can live your dreams.
Let us look at two situations – one in which a family is managing its cash, quite well and another in which a family is managing its finances according to a plan.
Ram is a construction worker and earns a daily wage of Rs. 250. During the month, he takes some days off. So, on an average, he earns Rs. 6,000 a month. He gives his wife Rs. 3,000 to run the house – pay for the groceries, vegetables, milk, etc. He keeps the remaining money with himself. Some of it is used to pay the children’s fees and other bills; some is used when he has to travel to sites which are not within walking distance of their home; some of it he spends on buying clothes or toys for the children or gifts for his wife. He alsokeeps a little money aside in a box in his cupboard that comes handy during Diwali. If relatives drop in, this amount is totally spent on them and they have less to spend on Diwali. At times, Ram borrows a little from the local money lender. His wife also keeps aside a little money from the Rs. 3000 she gets Sometimes she collects enough to buy a little gold on Akshaya Tritiya or some festive occasion. This is an example of cash management...
What happens if they have to buy an appliance for the home that costs Rs. 10,000? It seems too far out of their budget to even think about buying such an expensive item But if it is really required, they may take a loan from the money lender and then repay around Rs. 15,000 over the period of a year. If collecting Rs. 10,000 within a year is a difficult task, paying back Rs. 15,000 within a year is even more difficult. And, as the loan goes into the next year, it increases to Rs. 20,000 and so on...
Now, let’s see how things could be different if Ram and his wife undertake financial management instead of cash management.
If Ram and his wife actually sit down and draw up a family budget, they will realise that they need a maximum of Rs. 3,500 per month for all their household expenses. This will include stocking up groceries for the month, buying vegetables, fruit and milk and paying all the bills and fees. This means they are left with an amount of Rs. 2500 as savings.
They could set aside Rs. 250 for emergencies and surprise guests, Rs. 300 per month for spending on the kids and entertainment and Rs. 850 towards the house hold appliance that they want. They could also keep aside Rs. 300 per month for Diwali spending. Ram will realise that a bus ticket to far away sites and back does not cost more that Rs. 4 per day, and he rarely works so far off; perhaps for one week in the whole month. So he does not need more than Rs. 30 for travel. So, if Ram and his wife share the remaining Rs. 200 each, they can both manage their out-of-pocket expenses for the month.
At the end of the year, without compromising on their basic necessities, they have the household gadget with a little money to spare. They also have Rs. 3000 to spend on emergencies or guests. If neither pay them a visit, the money can go towards buying a little gold for Ram’s wife. They also have Rs. 3,600 for their Diwali spending. In fact, Ram is so inspired by the goals that they have set for the year that he puts in more working days every month and can even buy his wife a little gold, even if emergencies and guests claim their allocation. That’s the beauty of financial planning!
At the end of the little lesson on Cash management and Financial management, Pareshbabu asks Vimla and Arvind if they could point out in one sentence what the difference between financial management and cash management is...
They have many observations but in the end he explains: It is the ability to see money as a means to an end!In other words, setting goals and then allocating money towards these goals is what stretches your money more than you can imagine.
Having understood the importance of financial management, Arvind comes back to what Pareshbabu said at the beginning of the day: “It involves everything from budgeting and goal setting to spending, saving, investing and insuring and finally leaving a will for your near and dear ones.”
“So what you are saying is that meeting goals is what motivates every financial planning activity?” asked Arvind.
“You have understood me perfectly!” replied Pareshbabu.
“Once you set a goal, it motivates you to draw up a budget. That is the first step towards achieving your goal. Once you know how much you earn and spend on an average, you can gauge what amount of money you can dedicate towards saving and investing.”
“What about insurance? Where does that come in? Some people tell me that it is just a waste of money...”
“My dear Arvind, it is the foundation on which you must build your financial plan.”
“And why is that?” Asks Vimla, as she begins to serve them a feast of foods.
“It takes care of the chance that one or both the earning members of a family die unexpectedly. In such a situation, should all the goals of the family be abandoned? Certainly not. Nothing can compensate a family for the emotional loss that they face when a member dies. However, having insurance can make things a little less stressful by securing them in terms of money.”
“I understand and agree completely,” said Arvind quickly, sensing that his wife was about to begin on an emotional note about how life would not be worth living after the loss of a loved one. “We must be practical,” he added. “That is what will keep the family moving forward.”
“And what about making a will? How does that fit in with financial planning?” he asked, trying to divert his wife’s attention from the thought of losing loved ones....
“If you look at it as part of your financial plan, it’s a way of ensuring that your final goal is achieved.”
“And, what would that be?” asked Vimla.
“It is a way to ensure that your plans for your money and belongings – who these should go to - are carried out as per your wishes.”
The conversation suddenly decreased as all three of them got busy eating the delicious food that Vimla had prepared. All thoughts of financial planning were temporarily forgotten...
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Once they had finished the grand meal and were relaxing in the courtyard, sipping steaming hot cups of tea, they were all eager to carry on hearing about financial planning.
Pareshbabu took the lead again. “By now, you are quite clear that once you set goals, it is only a matter of planning how to achieve them in the quickest possible way. So let me ask you a little question. Suppose your goal cost you Rs. 12,000. Would it make more sense to save Rs. 1000 per month for 1 year or invest Rs. 1000 a month for 10 months at the rate of 12%?”
Arvind who was quick to catch the point replied, “Naturally, we would prefer to invest instead of merely saving. When we invest, our money is earning money too and that makes our goal achievable in a shorter period of time!!”
“Exactly!” replied Pareshbabu. He explained for Vimla’s to understand. “When you save, it is just your hard earned money that will go towards paying for a goal. However, when you invest your money, you will receive a return on it. This means that the amount that you require will be collected sooner. In fact, like your wise husband here agrees, by investing, you are making your money work too!”
“Now I understand. But how will we know which financial product to invest in? You have told us about so many products...” she replied.
“Here again, your goal will guide you,” he replied. “If you wish to buy a car after a year or two or take a trip to Dubai, you will invest in short term instruments like bank deposits and short term mutual funds. On the other hand, if you wish to collect a large amount of money for your daughter’s marriage which is likely to be 15 years from today, you must invest in long term products like shares, Post office savings and insurance.”
“How simply you have explained things to us Pareshbabu. I am so glad that we met at that tea stall the other day!” exclaimed Arvind.
“Talking about tea stall, I promised to drop in on one of my students by tea time...I must leave now. I hope that you are clear about the principles of financial planning. More importantly, I hope it enables you to meet all your goals. Especially your trip to Dubai!” he said with a smile.
Both Vimla and Arvind thanked him very much and walked with him till the door. They promised him that they would begin their financial planning exercise sincerely right away.
Source: Portal Content Team
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