What is Personal Finance?
If we talk about financial literacy for teenagers in India, a remarkably small percentage have a clear understanding of it.
Approximately 74% of teenagers need more confidence in their understanding of money matters.
A few important concepts of Personal Finance Teens need to know
Difference between Needs and Wants
Needs are basic things we need to survive and live well, like food, water, shelter, and clothes. Everyone needs these things, no matter where they're from. It's really important to take care of our needs because not having them can make us sick or unstable.
Wants are different. They're things we'd like to have but don't need to live. They make life better and more enjoyable, but we can live without them
While managing your finances, you exactly need to know how to manage spending between them,
Relationship with money
Developing a healthy relationship with money involves a few key steps:
Talk about money openly with your family.
Be honest about financial mistakes and learn from them.
Treat yourself without feeling guilty.
Avoid comparing your finances to others.
Time Value of Money
Understanding the time value of money is crucial in managing your finances wisely. It means that the money you have now is more valuable than the same amount in the future because it can earn interest or grow in value over time. This concept is important for making smart decisions about saving, investing, and spending.
Taxation
Understanding taxes can seem daunting initially, but once you grasp the basics, it becomes clearer what to expect from your earnings.
Know the difference between gross and net income. Gross income is what you earn before taxes, while net income is what you take home after taxes are deducted.
Learn about income tax brackets. Your tax payment depends on how much you earn and how you earn it, so it's essential to be familiar with these brackets.
Find out if your income is tax-exempt. Some types of income, like gifts for teens, may not require you to pay taxes on them.
Budgeting
It would be ideal to have enough money for all your needs, whether essential or not. However, real life often determines our financial choices.
Budgeting helps ensure you don’t overspend. It lets you plan for both immediate and future expenses. It’s a smart way to handle your money before things get out of hand. Ideally, you’ll have savings. If not, it can still prevent you from going into debt.
Investing
Investing means putting your money into something with the hope that it will earn you more money in the future. It's a smart way to manage your money and achieve big financial goals like buying a house or saving for retirement.
Starting to invest when you're a teenager is a great idea because you have lots of time for your money to grow. A study by Greenlight found that many teens are interested in investing, but most of them need to learn how to get started. Investing doesn't have to be super complicated, but there are a few important things to remember.
Start As Early As Possible
At this point, you must be wondering-
- “ I am young, What’s the hurry? “
- “ I do not have the time for this “
- “ I don’t understand this “
- “ I don’t make enough moolah for this “
Well, it’s only natural that these thoughts spring to mind when you are about to embark on something considered to be an adult affair in today’s society. However, consider this, aren’t these excuses we all make at some point in our lives? And more so for the good things- dieting, exercise, homework, or any other good habit, we want to commit ourselves to. These mental blocks have to be overcome, they hold us back from unleashing our true potential.
Moving forward, we are all self-aware of the stature of money. It is quintessential for our survival. So much so that most of us are stressed about it. A Cigna TTK wellbeing survey in 2018 indicated that around 82% of Indians are stressed over work, health & finance-related concerns.
We worry about our future well-being at the expense of today. Doesn’t sound like a good deal right?
I’ve seen ladies & gentlemen, irrespective of their financial status getting wrinkles on their forehead by just ruminating about these expenses- their child’s education, a big fat Indian wedding, a new car, a bungalow & even after providing for all this they want to leave behind something for their grandchildren too.
Noble thoughts, indeed. But is it worth being anxious about their entire lives? All these expenses can be well taken care of by managing one’s finances in the right way. It's not rocket science.
As a teenager, the biggest factor in your favor is time. You can choose to make your entire life tension-free by being prudent with your money. And those who start early, receive a major head start (More on this later)
Recount the thrill of outpacing others in a Need For Speed race with a NOS engine. This is no different, although it certainly conforms to the law.
Remember the old saying- "Time is money."
You are at an advantage with Personal Finance over the majority. And most certainly it is so because you are young & have time on your side.
Note: "No amount is too small to start your journey of financial freedom.” Rather, it is extremely important to start early, as we saw in the above table. We will discuss more on this topic in the next unit.
No Amount Is Too Small
Savings are the foundational crust of your personal finance journey. Adopt the habit of saving a portion of whatever money you earn/receive.
Trust me, it is a reckless habit to splurge your entire income and it will lead you nowhere. You will just be living a life that goes paycheck to paycheck. It is all happy and fun when the sun is out but the boat risks being capsized on a rainy day. Unexpected expenses are bound to occur and you must be prepared for any such contingencies.
Do not be disillusioned that savings are meant only for people with regular paychecks. Small amounts add up to a huge number.
Learn the art of prioritizing your expenses. You don’t have to become a miser in this process, but the basic idea must be clear to you- spend on your needs, and save on your wants. Spending less on unimportant things in life will leave you with a better chance to have everything that matters the most.
In my case, vacations have always topped the priority list. It takes me around six to eight months of absolute penance to save up for a nice outing. I often feel the sudden urge to spend it all on clothes, food, and gadgets but I have successfully been able to keep them in check, at least till now.
So, What’s been on your mind lately?
You can get what you want with just a little frugality.
Go the extra mile to save a few bucks wherever possible. Cut down on those extravagant coffee dates, ditch the car, and use public transport instead, and avoid splurging on so-called bargain deals. These little steps will go a big big way in realizing your objectives.
“Beware of the little expenses, a small leak will sink a great ship“ - Benjamin Franklin
Stand Out From The Crowd
In the last unit, we read a beautiful quote from Benjamin Franklin. Like him, we all aspire to do great things.
However, there is one particular habit that segregates ordinary men from the creme la de creme fraternity.
A reflection into the thought process of a foolish person:
Savings = Income - Expenditure
A reflection into the thought process of a wealthy person:
Income - Savings = Expenditure
This mantra shall serve you well for the remainder of your life.
No, this is not a rat race to finish at the top of the charts. Money, in itself, does not have any value, it is paper. Money is just the means, not the end. Financial planning is nothing but a healthy lifestyle. And we are adopting it to pursue the life we want to gift ourselves and our loved ones.
We will also try to highlight a few other common mistakes youngsters make during their formative years.
The most noteworthy among them are spending extravagantly on liabilities as soon as one gets a full-time job with a regular income.
What are liabilities?
On a personal level, all those materialistic things that do not generate any corresponding income can be termed as liabilities. This includes the dreams of every common man- fancy cars, electronic gadgets, sprawling bungalows, plush interiors, and everything else. All these expenses fall into the broader category of liabilities.
It is not at all advisable to do. At a tender age, the propensity to save is high. This is because you do not have to cater to any fixed expenses. You have the full liberty to save a hefty chunk of your income ( unless the household isn’t running smoothly). As you grow old, you are more likely to be burdened with overheads such as rent, household bills, and every other frivolous item you can think of.
In essence, the best time to start saving is as soon as you get a full-time job. Next, sit back, relax, and watch your wealth grow exponentially.
Exponentially? How is that possible?- We will get to that in our upcoming units.
Beware of Modern-Day Theft
By this time, you must have a basic idea about the concept of inflation. It is the decrease in purchasing power on account of a sustained price rise for a basket of goods and services.
In the words of Sam Ewing, “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair”
My parents are lovely people but they do not leave behind any opportunity to say things like:
“We used to be happy with just five rupees and look at yourselves, not satisfied with even a thousand”
“This thing cost pennies (aanas) back in our time. Is it even worth the price you are paying?”
Well, at least you know what to do the next time you encounter a similar situation.
Getting back to our topic of discussion, savings cannot be kept in the form of idle cash at home. Cash in itself is a depreciating asset. It loses its value over time. The purchasing power of the same ₹2,000 banknotes will not be the same after five years as the price of corresponding goods & services would increase by a sizable amount.
To put things in perspective:
A very popular saying in the world of finance goes like:
“There are no free lunches “
Every time the government prints more money it is indirectly stealing from the pockets of the common man. How so you may ask.
It is assumed that the printed money is spent on goods and services for the benefit of the common man. Increasing the supply of money in the economy drives down the purchasing power of the currency. Think of it this way- more money is chasing the same bunch of goods & services. Hence, when the supply of corresponding goods & services cannot be increased by a similar proportion, the prices increase. You now have to shell out more money to buy the same amount of stuff.
Hence, it is always advisable not to keep your savings in the form of idle cash but to invest that will help you grow your money exponentially.
The Returns Dilemma
Now that we have established the need to invest our money let us look at the available alternatives.
To avoid depletion of our resources, we must lend our money to those in need of it and earn interest on the same.
As individuals, we cannot lend directly, so we entrust this responsibility to a bank that acts as an intermediary between borrowers & lenders. It is assumed that the bank loans out the entire amount we deposit with it, after keeping a certain percentage as reserves. The bank earns a spread by acting as a liaison between the two i.e. it lends funds to corporations at a higher rate than paid to the depositors aka Net Interest Margin (NIM)
Here comes the catch - most savings account holders earn around 3% per annum on average on their deposits. Whereas the annual inflation rate hovers around 6-8%:
It is amply clear from the above graph, that savings account earnings barely manage to beat the inflation rate. In essence, investing our surplus funds in savings account deposits will scarcely protect it from erosion- there will be a loss of purchasing power.
Fixed deposits are a tad better on this front. The average interest rate earned on fixed deposits greater than 365 days ranges from 4.5%-6% per annum. At this rate of income, the value of money does not erode over time- the purchasing power of money is intact.
However, our objective is entirely different. We are investing our money with a view to earning a little extra return over and above the inflation rate. This is precisely how we can grow our wealth. Beating inflation in terms of returns is not subjective, it is mandatory.
The Way Out
So, the next logical step here is to hunt for alternatives that provide some leeway in terms of returns. Although not exactly an appropriate gauge, historical returns of different asset classes can provide some inferences about the kind of future returns.
1) Gold- The yellow metal is a classic favorite amongst Indians. It is considered as a great inflation hedge and has been known to outperform other asset classes during periods of economic downturn.
In the past twenty years, Gold has given absolute returns of around 1000% and annual compounded returns of approximately 12.70%. Attention must be paid to the fact that the returns given by gold are double that of traditional fixed deposits.
Investing in gold requires one to be cautioned about:
- Making charges- Since we are buying gold purely for investment purposes, stick to bullion bars instead of coins, jewelry, and other artifacts. You will end up paying hefty making charges for the same which will naturally reduce your overall return.
- Selling charges- Buying & selling physical gold can be an expensive affair. It is best to stick to Gold ETFs for investing since it is safe & cost-effective. There is no minimum investment amount as well.
- No passive income - Unlike stocks that pay dividends, gold does not provide any interest income.
Gold is a strategic defensive allocation best suited for conservative investors with a low-risk appetite. Investors must consider the Sovereign Gold Bonds (SGBs) issued by the Government of India if they intend to invest in gold for the long term (greater than eight years in this case) else Gold ETFs are the best available option. SGBs provide fixed interest income @2.5% p.a. In addition to appreciation benefits that make it a lucrative option.
We recommend going through this module to get a better idea about gold as an investment option.
Our opinion - Allocate 10-15% of your total funds to gold as a safety hedge.
2) Equity - is perhaps the only legitimate asset class(not considering cryptocurrencies) with the potential to consistently deliver returns superior to the inflation rate. Let us look at the past performance of the headline indices Sensex & Nifty 50 have performed:
The Sensex and the Nifty 50 have handsomely rewarded investors with returns of roughly 14% CAGR in the last 20 years, greater than any other asset class.
The thumb rule for equity investing is: 100-Age = Equity Percentage Allocation
For instance, if you are aged 20, you must invest 80% of your funds into equity and the remaining 20% in defensive bets. As simple as that.
Why Are We Gung-ho On Equity?
Earlier in this module, we learned that the equity asset class has the potential to consistently deliver returns more than inflation.
Here on, we have established that equity returns in the past twenty years have been way ahead of any other asset class. But this is certainly not the complete picture.
The Sensex & the Nifty 50 index highlight the performance of the largest, most active & liquid companies listed on the Indian Stock Exchanges. These companies are considered to be fundamentally strong & dependable with a proven track record, also known as large caps or blue chips.
As per SEBI (Securities Exchange Board of India), the Top 100 companies in terms of market capitalization (valuation of the company based on the total no of shares * current market price of each share), are reckoned as largecaps.
Now, What about the performance of companies further down the list aka Midcaps (101st-250th) & Smallcaps (251st onwards)?
Let us see:
You will be appalled to know that the Nifty Midcap & Nifty Smallcap Indices have outperformed their large-cap peers by a stellar margin- delivering CAGR returns of 24.35% and 16.15% in the past twenty & seventeen years respectively.
The returns on the Nifty Midcap index are almost 8x that of savings accounts, 4x of fixed deposits and 2x that of Gold.
Mind-boggling. Isn’t it?
Now let us shift focus to the charts, observe carefully all three of them- Nifty, Midcap Index & The Smallcap Index.
What do you observe?
1)Stocks are upward trending- This is our first natural instinct as soon as we observe any of the charts. Stocks are in a long-term uptrend and this trend is unlikely to reverse any time soon. There is a strong correlation between economic growth and stock market performance. In essence, as long as the growth levers of the Indian economy are in place, stock markets shall continue to be buoyant.
2)Stocks are volatile - compared to other financial instruments that provide fixed returns every year. Neither do they move linearly in one direction. Stock prices fluctuate every second based on demand-supply dynamics. Although it may sound like a negative feature about equities, smart investors know how to make volatility work in their favour. Buying on market declines is an excellent strategy and works well for long-term investors.
You must have noticed a striking similarity between all the three charts. I have pointed out the same in the chart of Nifty 50 below and you can compare this feature in the other two as well:
Notice how stocks corrected drastically three times in a twenty year history- 2001, 2008 & 2020. The Nifty 50 Index fell between 40%-60% from its peak on these three occasions. To give you an idea of how scary things were, Imagine a ₹1,00,000 portfolio being reduced to ₹50,000 in a matter of months.
Panicking investors sold off their stocks at rock-bottom prices whereas the smart ones were busy accumulating their favorite companies. You will notice that eventually, the market punished the panic mongers by scaling another peak. By buying at such throwaway prices, investors benefited hugely.
Prudent investors know that volatility is actually a boon if you are committed to long-term investing. They usually buy more when people are selling in large hoards. And that is precisely how they stay ahead of the curve.
Present-day, countless Midcap & Smallcap stocks are up more than 5X to 10X from their lows of the 2020 crash. Yes you heard it right, 500%-1000% returns in just a little over one year.
The list goes on and on. But what about the blue chips?
To give you a perspective, they aren’t lagging behind in terms of returns.
The key-takeaways from this section are:
- Stocks are in a long-term uptrend.
- Volatility is a boon and we can make it work to our favour.
- Large cap companies have an established track record and are best suited for investors with low risk-appetite.
- Midcap & Smallcap stocks have delivered better returns than their largecap peers but carry higher risk.
- Patience is a gifted virtue and more so for long-term investors.
- Investors must not panic when the market falls but instead add to their positions if they are confident about the prospects of the company.
- Returns are quadrupled when stocks are bought on market declines.
How To Start?
Now that we have understood the benefits of equity investing from our last unit. Let us learn, how do you start your investing journey?
There is more than one answer to this question depending on one’s lineage, field of interest & available time.
Choice 1- Leave it to the professionals
Firstly, it is important to know if you are suited for this- students in an unrelated field, those with a poor history of managing finances, those with little or no knowledge about how the stock market works and lastly for people with limited time.
People belonging to this pie must opt for professional management of their money. No, it’s not a costly venture and will bring in much needed discipline to your saving culture. There are two tools using which you can start your journey:
a)Mutual Funds via SIP -
Basically, mutual funds are pooled investment vehicles that collect funds from various individual investors and diversify the same amongst available investment alternatives.
Mutual funds are managed by experienced Portfolio managers that charge a certain proportion of the total AUM (Assets under management) as their fees. The total gains and losses of the fund are distributed proportionately amongst investors.
The units of a Mutual Fund are traded on the Stock Exchange at their Net Asset Values (NAV)
Simply put, a Mutual Fund with assets (money pooled by investors) of ₹10,000 and total outstanding units amounting to 50 has a NAV of ₹200.
Now, if the value of the total assets rises to ₹11,000, the NAV of the fund would increase to ₹220.
An investor who bought units of the fund at ₹200 can sell them for ₹220 to pocket a 10% gain.
Enter, the concept of SIP or Systematic Investment Plan. Our goal here is to accumulate wealth over time and SIP comes in as a handy tool to help us fulfill our objective.
With SIP, we can invest a fixed amount in certain intervals on a fixed date, say the 1st of every month or the 2nd Thursday of every month as per one’s convenience. Investors can start with as low as ₹500.
With this fixed amount, mutual funds units are brought at the prevailing NAVs. This weeds out the risk of market volatility by averaging our cost of purchase.
SIP investing can be done discretionarily such as by investing double the usual amount when the market is in a bearish mode. The NAV’s will be lower when the market is correcting and hence investors can use it to lap up their favorite companies at reasonable prices.
Click here to learn more about Mutual Funds.
b)ETFs or Exchange Traded Funds-
mimic the performance of an index, sector, commodity or asset class.
For example, the returns on the Nifty 50 ETF will be similar to that of the Nifty 50 Index.
An investor looking to gain exposure to the markets, can buy all the fifty stocks individually and the returns will still be the same. However the flipside to such an approach, is the high transaction costs involved with frequent buying/selling each stock discreetly i.e. rebalancing the portfolio.
ETFs on the other hand are a cost efficient manner of investing in the stock market. ETF Units trade just like Mutual Fund units on the stock exchange. The transaction charges are almost nil and it is very easy to buy/sell units as and when desired.
Investors can simply add ETF units at fixed time intervals or on market declines to eke maximum gains.
Choice 2- The DIY Investor
This is best suited for all those intrigued by the stock markets and have taken up a related field of study.
We believe that financial illiteracy is a serious impediment to the economic growth of the nation. The entire team at ElearnMarkets is dedicated to empower the retail investor with cutting-edge resources and know-how at his disposal.
The StockEdge App is an in-house tool that can be of great utility for everyone ranging from day traders to investors.
Besides, we have a bunch of carefully curated content on ELM School for newcomers curious to learn in greater detail about the stock market.
