Budget
- know and track where to spend how much
- these apps can connect to bank accounts, give reminders and suggestions, etc
- 50:30:20 rule - this is not rigid. 50% on needs, 30% on wants and 20% on savings
- e.g. we need food, but we want to eat out
- first, start to track these continually. then worry about the ratios
- todo - figure out the right apps. e.g. empower, ynab, mobills, mint, personal capital
- “fixed expenses” like rent are cannot change as easily
- for fixed expenses - we need to be aware of competition, then be able to negotiate, etc
- “variable expenses” like shopping can be controlled much more easily on day to day basis
- go for the cheaper “unit price” of goods we buy
- e.g. larger shampoo bottles might cost us lesser than the smaller ones
Emergency Fund
- unexpected costs like medical bill, layoffs
- these can have catastrophic impact on us
- method - set it up so that money goes from “checking account” to “saving account” automatically
- additionally, accounts can also have a minimum balance requirement
- “emergency fund” - have at least 6 months worth of funds on the reserve
- recall the 50:30:20 rule - all funds savings should go here first, until we have built the emergency fund
- for emergency fund, we would only consider needs i.e. the 50 part
- e.g. if we want to build an emergency fund of 3 months, and if we follow the 50:30:20 rule, we would need to put away our savings towards emergency funds till 7.5 months
- todo - have separate savings accounts for each type of expense, since there aren’t any limits on the number of accounts we can have
Pay Yourself First
- “pay yourself first” - the idea is that when we receive our income, based on our goals, we should set aside small amounts along with every paycheck
- so, instead of spending first and then saving the rest, we first save and then spend the rest
- e.g. if we want to buy a two wheeler in a year’s time, we divide its cost by 12, and set the resulting amount aside every month for a year
- the frequency should be automated to be on the same day as the paycheck, so that it is transparent to us
Different Types of Accounts
- “checking account” - for daily spending, less restrictions on withdrawals and less interest rate earned
- “saving account” - for accumulating, more restrictions on withdrawals, more interest rate earned
- “high yield savings account”, “money market account”, etc - these are special types of savings accounts, but with even more interest
- however, if we withdraw earlier, interest rates might for e.g. change to be the same as savings account
- banks for e.g. use this to lend money to businesses for short periods of time, and make good interests on it
- i believe businesses use “cash credit” (or cc) accounts. they use these accounts to withdraw money for short periods of times. and this what helps banks fund the high yield savings accounts / money market accounts
- “certificate of deposit” or “fixed deposit” -
- lock in period of couple of months to couple of years
- upside - we get an even higher rate of interest
- downside - penalty if we withdraw that cash earlier
Interest
- “interest” helps grow money over time
- e.g. if the bank gives us 1% interest rate, we get 1% increment on 500$, but the next year, we get it on 505$
Credit Score
- when we go to buy a car at a dealership, they run some background checks on our finances etc
- based on our “credit score” the interest rate we have to pay for the car loan changes
- it ranges from 300-850 - e.g. a credit score of 800 is very good, and 500 is poor
- credit score shows how likely a person is to make their payments timely
- so, the dealership charges extra interest rate for people with a poor credit score, for the risk they bear by giving out the car to defaulters
- credit score does not look at employment status, our income, etc
- there are three credit bureaus - trans union, experian, equifax. they assign us these credit scores
- “credit report” - it is like a report card of our payments, dues, etc
- each of the three credit bureaus allow us to view our “credit report” for free once every 12 months
Maintaining a Good Credit Score
- make our payments timely
- we should continually monitor for outliers, e.g. we should “dispute” a transaction we think we never made
- lesser known - “credit utilization” - fraction of credit that we use. e.g. we have 10000$ of available credit, and we are using only 100$
- the lesser we utilize our credit, the better our credit score would be - use < 20% of the credit available
- length of credit history - maintaining a good credit history for a longer time helps get a better credit score
- types of credit - having some diversity, e.g. home loans, car loans, etc might also help
- if we have too many new credit applications, it can lower our credit score, since we are borrowing too much
- “hard inquiry” - happens when a financial institution checks our credit report as part of a “lending decision”, e.g. when applying for a car loan. it impacts our credit score
- “soft inquiry” - happens when a company checks our credit report as part of a “background check”, e.g. when we apply for a job. it does not impact our credit score
- e.g. we apply for a lot of credit cards to get lucrative discounts. applying for credit cards involve hard inquiries. and hard inquiries inturn, lower our credit scores
Credit Cards
- “credit card” - borrow money from a bank / credit card company
- we pay it off little by little every month, with some additional interest
- pros of credit cards -
- we need to buy something immediately, but pay it back say at the end of the month
- helps build a credit score, which can help take loans etc in future
- credit cards give cash backs and reward points which accumulate
- less risky - e.g. if we can report a fraudulent transaction within 3 days, it is the company’s liability and not ours, since unlike in case of debit cards, it is the company paying on our behalf
- cons of credit cards -
- easy to overspend and get into a debt, since we do not have to pay for things right away
- if we do not make our payments timely, it affects our credit score
- we pay interests, which means we end up paying more
- there are different kinds of credit cards -
- “standard credit cards”
- “rewards credit cards” - they give rewards and cashback for shopping, but also have a higher interest rate
- “student credit cards” - have lower credit limits and interest rates. helps build a credit history as a student, which can help after graduation
- “business credit cards” - higher credit limit and higher interest rate. benefits like tax deductions
- credit cards have an “apr” (annual percentage rate) or “interest rate”, which is the amount of interest charged on “unpaid balance”. we should go with cards with a lower apr
- apr includes interest rates, costs like the “origination fee” (charge for processing the loan application) etc
- thats why, apr often indicates the “true cost” of borrowing money
- however, it does not include costs that are “contingent” like late payments. contingent means dependent on certain conditions
- “grace period” - amount of time we have to pay our bills, before the interest rates start applying. the date from when the apr starts applying is also called the “due date”
- because of this, we should try to pay off immediately if possible, but sometimes we cannot
- credit cards might also have an additional “annual fee”, which we pay for using the credit card
- “balance transfer fee” - fee when we migrate from one credit card to another. e.g. if it is 3%, our balance will change from 1000 to 1003 i.e. now, instead of 1000, we have to pay back 1003
- “cash advancement fee” - receiving cash via credit cards. this use case is not what credit cards were meant for, hence there is a fee associated with it
- we can only spend up to the “credit limit” when using credit cards
- “schumer box” - credit cards have to include this as part of their marketing materials in united states. it contains key information about the apr of the credit card etc
- e.g. if a person does not intend on having any balance, they need not look at the apr section of the schumer box, and should instead look at the sections like annual fee
- e.g. if a person does not travel internationally frequently, they need not look at the benefits for foreign transactions in the schumer box
- apr can be “nominal” or “effective”. applications usually list nominal, which does not include the compounding effect. effective includes the compounding, and is often how it actually works
- e.g. 12% nominal would mean 12.68% effective with monthly compounding, and 12.75% effective with daily compounding
- my understanding - e.g. monthly compounding means every month’s interest rate would be 12/12 = 1%. then, (1 + 1/100)^12 = 1.1268250301 i.e. 12.68% interest rate
- similarly, (1 + 12/(100*365))^365 = 1.1274746156 i.e. 12.75% interest rate
- interest rates can also be “fixed” or “variable” (subject to market change)
Payment Methods
- cash - advantage - widely accepted. disadvantages - difficult to carry around, unsafe, difficult to keep track of where we spend our money on, etc
- “credit card” - we borrow money, and we don’t pay any interest if we make our payments timely
- “debit card” - money is coming out right out of our account
- debit cards are much faster than the older method of cheques - it took time to write and validate cheques etc
- we would end up with a “bounced” cheque if we had insufficient funds
- people also use “direct transfers” for transferring money from one account to another
- “rent to own”, “store credit”, “layaway”, etc - e.g. for appliances. we pay a weekly or monthly rent on the goods till we are able to pay it off. this looks like an informal method of using credit cards to me. there might be differences e.g. in layaway, we get to own the item after the payment is entirely complete
Money Personality
- there are four kinds of people (self explanatory) - saver, investor, spender and balancer
- now, we list the different kinds of “biases” people can have
- “loss aversion” - we are scared of losing money, and therefore we do not invest it
- “endowment affect” - we attach more value to stuff than it actually has, for e.g. not selling it at the right time
- “herd mentality” - follow others, e.g. we invest in crypto just because everyone else is doing it
- “anchoring bias” - we put too much importance on the first piece of information we get, e.g. if we see a jacket of 500$ being sold at 300$, we think its cheap, regardless of it being sold at a cheaper rate elsewhere
- “present bias” - we prefer immediate happiness over future benefits
Charitable Giving
- “altruism” - desire to help others / make the world a better place
- others might say that they get a “tax writeoff” by doing this
- but usually, you are giving more than you are receiving, even with the tax write off
- research - tax benefits can be claimed on charities, not on “fund raisers”
SMART Goals for Finance
- s - specific - i want to save money for an emergency fund
- m - measurable - i want to save 6 lakhs for the emergency fund
- a - achievable / r - realistic - i want to put aside 40 thousand every month towards this
- t - time based - i want to build this fund by 1 year
Short, Medium and Long Term Goals
- “long term goals” - more than five years. high risk. do not change much. invest your money in a growth oriented way for this, e.g. stocks, bonds, etc
- “medium term goals” - one to five years. moderate risk. invest your money in mutual funds, certificate of deposit, etc for this
- “short term goals” - less than a year. low risk. can change frequently. put your money in bank account
Financial Plan
- it has four major components listed below
- “budget” - helps us track how much we earn, spend and save
- “savings plan” - how much we save each month for our short, medium and long term goals
- “debt repayment plan” - plan to pay credit card, car loans, etc. helps reduce debt, increase credit score, etc
- “investment plan” - invest your money to grow wealth. helps diversify portfolio, diversify risk to return, etc
- difference in investment and savings plan - investment plan is for a longer duration. “long term goals” in savings plan is for e.g. for buying a house, while an investment plan is more towards growing wealth
Net Worth
- assume a person has a house of 500k, car of 50k, jewellery of 5k
- now, assume she / he also has mortgage of 400k for the house, car loan of 40k, and student loan of 50k
- so, the “net worth” of the person would be the difference between the sum of assets and the sum of liabilities
- this value in this case would be 65k
Credit
- different kinds of credit have different interest rates
- “merchant loans” - offered by businesses to their customers. e.g. a dentist might sell such plans to patients. they might partner with banks as well. they might also have flexibility in their plans, based on the duration and interest rates
- people look at things like income, dti ratio, employment history, credit score, collateral, etc before lending
- dti - “debt to income” ratio - the lower this is, the better for lenders. e.g. our gross monthly income is 4500, and every month, 1500 of that goes towards repayment of loans. in that case, our dti ratio is 30%
- “payday loans” - for small periods. they have very high interests. we pay it on the next day we receive our paychecks. they are used in case of urgent requirement
- “title loans” - again for small periods and have very high interests. here, we use for e.g. our car as collateral, and if we fail to repay the loan, the lender can take away our vehicle
- “subprime mortgages” - given to people with poor credit score, at high interest rates to make up for the risk
- “predatory lending” - lenders use unfair tactics like high interest rates for desperate borrowers
- such loans are usually obtained from unreliable, informal lenders and should be always avoided
Types of Loans
- “installment loans” - we borrow a large amount of money and pay it back in installments
- “resolving loans” - e.g. a credit card. use up to the credit card limit. we constantly keep borrowing and paying
- note - the interest with “installment loans” is fixed. we pay “simple interest”. the interest is on the principal amount, and it does not compound
- so, interest in resolving loans can feel relatively higher. if we do not pay timely, it can compound and become even higher
- “secured loan” - like home mortgages, auto loans, etc, where the house / car itself becomes the “collateral”. the lender takes this away if we cannot pay back the loan
- “unsecured loans” - like credit cards. they for e.g. just affect the credit score.
- again because of this difference, the interest rates with secured loans are relatively lesser when compared to unsecured loans. also, the amount we can borrow using unsecured loans would be lesser when compared to secured loans
- note - we also have “secured credit cards”. here, we deposit an initial amount called the “security deposit”. this is the maximum amount we can spend using the card. use case - helps build credit, for people with low / no credit scores. banks also promote people to unsecured credit cards, when they show responsible use of secured credit cards
Debt
- “good debt” - borrowing money to invest in assets that grow over time. e.g. education loans, home loans, etc
- “bad debt” - borrowing money to buy a tv, outfit, etc
- “high rate method” - pay the loans with higher interest rates first. this is the optimal method / right way to pay off debts. it is also called the “avalanche method”
- “snowball method” - paying the loans with smallest “balance” first. this is not optimal, but people follow this method out of psychology, to get some debts out of the way
- “debtor” - person borrowing the money. they “owe” money, “creditor” - person lending the money
- “chapter 7 bankruptcy” -
- also called “liquidation”
- we say that we are unable to pay our loans
- the bank then seizes all our assets, and then declares us “free” of all debt
- the assets are used to repay some of the amount to the creditors
- so, this gives a chance for a fresh start
- we can only file for it in certain cases, e.g. we cannot file it for student loans, child support, etc
- our credit report shows bankrupt for 10 years. this makes it difficult for us to obtain any future loans
- “chapter 13 bankruptcy” -
- also called “reorganization”
- the terms are revised, e.g. the tenure we have to pay it off in is increased, the interest rates are lowered, etc
- again, this will reflect in our credit report
Managing Risk
- “risk” in finance examples - loss of assets like home, loose earning potential, medical expenses, liability (being sued for something that involves financial loss), inflation, theft, etc
- risk and return relationship - higher the risk, higher the potential return
- “risk management” - identifying, analyzing and then responding to risk
- “avoid” / “reduce” risk when possible, e.g. take precautions when driving
- “retaining risk” - accept it, and deal with it via for e.g. emergency funds
- “transferring risk” - typically using for e.g. insurance
- insurance companies have a bunch of people called “actuaries” who look at statistics
- these people try to determine what premium insurance companies should charge to for e.g. stay profitable
- this is called “pooling” or “diversifying” risk. e.g. if the insurance company gets a premiums from 100 people, not all of them will fall sick at the same time, and so the company uses the premium from all of them to help pay for the losses of the few of them
- “insured” - us, who buy the policy
- “insurer” - the company selling the policy
- “agent” - can work for the insurer or be external, to help choose us the best policy
- “underwriter” - person at the insurance company who decides how much risk they are willing to accept for how much premium
- “premium” - amount people pay to the insurance companies to transfer the risk
- “deductible” - amount people have to pay out of pocket before the insurance company pays. e.g. if our medical bill costs 1500$ and our deductible is 1000$, then the first 1000$ needs to be paid out of our pocket. more deductible might mean lesser premium, and it might make sense, as we would want to claim the insurance for larger costs, and not smaller ones
- “policy limit” - the maximum amount the insurance company will pay for a claim
- “co pay” - a fixed amount the insured must pay alongside the insurance company. e.g. if we use special services like dermatologist, we will pay 30$ every time, and the remaining would be covered by the insurance company
- “claim” - when we ask the insurance company to pay, we are making a claim
- “benefit” - the amount the insurance company agrees to pay when we make a claim
- in case of healthcare insurance, the party paying the premium might be different
- e.g. as part of the aca (affordable care act) in us, there were several reforms like
- everyone has to have a health insurance, or else pay a fine
- subsidies by government for premiums of some people
- insurance companies cannot refuse or charge people more based on their previous health conditions
- insurance premiums can either be paid by individuals or by employer or by government. limitations on for e.g. services covered might be there when we go the employer / government route, but it does of course mean lesser burden on us wrt the premiums