Don't be silly about your money: 5 mistakes to avoid

Have you ever felt bad about your financial decisions? Building up a huge credit card bill and not repaying it for months, or taking a personal loan and not making regular payments towards it, are some of the common, and more apparent, money mistakes we make. Then there are those that we make unintentionally or due to ignorance. Efficient use of money involves understanding money as well as your spending behaviour. Here are five errors that you could, and should, avoid.

Being investment-shy

Holding excess cash means letting the value of money deplete over time. Factors such as inflation eat into it. Money lying idle in the bank account doesn’t mean that you are doing well. It needs to be diverted towards investments.

If you do decide to invest, don’t be too conservative; you will lose out on returns. Looking only at products that give guaranteed returns of, say, 8% or 9%, is a mistake that many of us make as we are trying to protect our capital. Fixed deposits (FD), for instance, are popular. But investors forget that even though this instrument returns, say, 8.75%, taxes and inflation will reduce this.

The need to protect capital comes from fear of taking risk. But risk is not a negative term. “Many investors don’t understand risk. The fear of capital erosion makes many people invest only in fixed income, and they lose out on returns in better products,” said Suresh Sadagopan, a Mumbai-based financial planner.

Not factoring in time value of money

Would you prefer `1 lakh today or `1.2 lakh after three years? The correct answer is `1 lakh today, because of time value of money. There are two things you need to consider: the interest you can earn and the rate of inflation; in other words, the change in purchasing power of your money. Say, you invest `1 lakh in a three-year FD with annual compounding at 8.75% per annum. You will get `1,29,650. But after taking into account inflation of, say, 6%, the real return will be only 2.59%, and that’s without factoring in tax.

One-income strategy

You may have a job and get paid regularly. But is that income enough? In most cases, it’s not. Investing helps generate additional income in the form of dividend, compounding interest or capital gains.

By investing regularly you can tap into the benefit of compounding interest, which essentially means you earn returns on the returns. For instance, say, you invested `1 lakh in an FD at 10% per annum for 10 years. If you don’t withdraw and let the returns be re-invested every year, in 10 years, you will get `2.6 lakh. But if you withdraw the interest, at the end of 10 years, all you will get is the capital `1 lakh, and `1 lakh in interest over the period (`10,000*10)—that’s a total of `2 lakh.

The earlier you start, more is the compounding benefit you get. You can get compounding interest benefit in both equity and fixed income products.

Favouring realty or gold

Buying only real estate, or buying a house that’s bigger than needed, is another common mistake. Many people believe that real estate delivers handsome returns and put in all their savings in realty. Another misplaced belief is that real estate will come in handy in an emergency.

In reality, real estate is an illiquid asset. It’s difficult to buy and to sell. Plus, there are legal issues, loan burden, delay in construction, and other problems to contend with.

While calculating returns on real estate, don’t simply look at the initial investment and the maturity amount. One must also factor in costs such as brokerage, stamp duty, registration fee, interest paid on borrowed capital, maintenance and repair costs, and municipal taxes.

Buying an overly large apartment for self-use is also a burden that should be avoided. For one, it means a home loan and commensurate instalments for a space that you won’t fully utilize. There will also be the added hassle of paying maintenance bills.

Similarly, many people look at gold jewellery as an investment product when, in reality, making charges drastically reduce the real returns. Buy jewellery only for the purpose of ornamentation, not investment.

Fearing debt

Debt is not bad, as long as you use it to buy assets, for example, taking a home loan. It hurts only when you overstretch or take it for instant gratification. For instance, using a credit card and then not paying the dues. Banks charge 22-44% interest annually on credit card dues. “Don’t over-leverage debt; avoid taking debt for unproductive consumption. For instance, living on credit cards without the discipline of paying monthly bills can put you into a debt trap,” said Sadagopan.

If your fear of debt comes from the concern that your near and dear ones will have to take on the burden of repayment in your absence, insurance could be the answer.

“You can take home loan insurance, for example. If you die before the loan is paid off, the insurer would pay the outstanding amount to the loan provider and your nominees will retain the house. Broadly, a cover for a `1 crore loan over 10 years will come for a one-time premium of `2 lakh-2.5 lakh,” said Kapil Mehta, managing director, SecureNow Insurance Broker Pvt. Ltd. If you foreclose the home loan, the insurance company refunds a certain percentage of the premium, he added.

Understand yourself, your money and where it is going. “Don’t copy products that your friends have bought. Build your own portfolio. Spend time in understanding investments. If you don’t want to get conned, sit down and understand the terms and conditions of a product before investing,” said Sadagopan. Ditch the fear of jargon and spend time understanding investment products that you want to buy. It’s the only way forward.