Last Updated on May 9, 2015 at 9:12 am
I had a chance to speak to the employees of a Hyderabad based mobile tech company. I wanted to build that talk around the terms of references needed for money management. I could think of three crucial objectives:
- insurance
- inflation
- peace of mind
I was able to cover the first two points but could not get to ‘peace of mind’. In this post, let us try and discuss it.
Type ‘comfort zone’ in Google and you will find a series of articles and imgaes which will tell you step out of your comfort zone.
With respect to a career or achieving things, I fully agree. “We must find our comfort zone and leave it” (source unknown).
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However, when it comes to money management, I think one needs to stay well inside one’s comfort zone, after recognising the importance of insurance and inflation.
For regular readers and personal finance aficionados, the first two terms of reference will be quite familiar. Nevertheless, let us run through them quickly.
Insurance
Emergency insurance*, life insurance, health insurance and accident insurance.
* with a cash stash
I have written enough about this and do not wish to say any further. If you are interested in knowing more, you can look at:
Notes on financial fortification
Inflation
The objective here is quite simple. Inflation devalues money. So when you have an expense in future, you need to ensure you have enough money to be able to afford it.
Factoring inflation is the key. How you choose to beat inflation is up to you.
You can either invest in equity and hope to grow your investments at a pace higher than inflation.
Or you can use fixed income (money-back policies, FDs etc.) products and invest more to compensate for a return lower than inflation.
Which bring us to ‘peace of mind’ or comfort zone.
Note: inflation has an impact on short-term goals as well. However, it is a bad idea to try and beat it with better returns. Too risky.
Use this tool to understand the importance of beating inflation with returns and/or with capital
There is more to investing than obtaining real returns
Peace of mind aka Comfort zone
Once you recognise the importance of the first two terms of reference, you need to choose instruments for implementation.
For insurance, the products are rather simple: pure term life insurance, medicalim, accident insurance policy, some rainy day money kept in SB account (for a start) should do.
Inflation is a tougher cookie to handle.
For people (like me) who were fortunate enough not to invest in any product before coming to know about inflation, the choice is simple:
equity (stocks) is the only instrument with highest liquidity and potential to beat inflation over the long term (min 10 years)
The simplest way to get equity exposure is via an equity mutual fund where a firm collects money from individuals and assigns a person to manage it by selecting the right kind of stocks.
One can also buy stocks directly and manage them, but that is a tougher proposition, in terms of digesting emotional upheavals associated with our decisions and market movements. Choosing equity funds is a simpler and relatively less stressful option.
If you wish to beat inflation with fixed income, then that is your comfort zone.
The trouble is with people who purchased and got used to fixed income products before understanding the importance of factoring in inflation. They have developed a sense of comfort, without understanding the nature of the financial goals they are planning for.
It would be disastrous if they wish to remain in their comfort zone of fixed income. That is the point of this post:
The terms of reference should be considered in the order in which is has been listed:
- Insure your financial life
- Factor inflation for financial goals
- Choose how to beat inflation within your comfort zone.
The plain truth is that most of us cannot beat inflation with fixed income, even on paper. We simply cannot manage to invest the amount necessary.
Hence, equity exposure is mandatory for most people. The amount of equity exposure can neither be too low (will not make an impact) or too high (too risky), but can be set to something comfortable ( I like 60% for long-term goals).
The other debate is stocks vs mutual funds (or stocks+mutua funds).
As long as inflation is factored in, it does not matter you do, as long as you comfortable about it.
Personal finance is all about peace of mind, but with basic fortifications in place.
Building a comfort zone cannot and should not be done overnight. It will typically take a few years to decide comfortable equity allocation (including 0%), whether to choose mutual funds or direct equity or a combination of both.
A comfort zone must be built with introspection – on what we think will work. Not what others think will work!
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