People usually start considering about their personal finances in their late 20s and early 30s. This age group is of the people who are fairly settled in their lives and careers. It is a good time to reflect on your personal finances and evaluate the progress made thus far, and also chart out the way forward. In this article we will go over the 6 biggest financial mistakes, one can make to worsen their personal finances.
Not having reserved funds in case of an emergency
The term “Emergency Fund” refers to money kept in reserve, that one can use in time of financial distress or emergency. The purpose of an emergency fund is to improve the sense of financial security by creating a safety net that can be used to meet unanticipated expenses, such as illness or loss of employment during a global financial crisis.
While some call having 1 to 2 months of wages in reserve an ideal amount ideal, most financial experts say that the recommended emergency fund amount should cover 3 to 6 months worth of household expenses. Although if you are self employed or are working in an industry with turbulent workflow, it is best practice to reserve about 6-9 months of wages in advance.
Poor insurance plan
Every individual must have an adequate amount of life insurance and health insurance. A life insurance will help your family handle the expenses incurred if you pass away as well as ensure that they have the resources to get through a difficult transition after you are gone.
Life insurance is often inexpensive for adults who are in good health, and the peace of mind it offers is simply priceless. Knowing that your loved ones have the resources to thrive after you are gone is one of the smartest financial decisions you can take.
You should have an ample amount of health insurance for your entire family. A health insurance is a type of insurance that covers medical expenses that may arise due to an illness or accident. These expenses could be related to the various hospitalization costs, cost of medicines or doctor consultation fees. You may receive a health insurance from your employer as a part of employee benefits, which is good in most cases. But, it is ideal to have your own family floater health insurance for the entire family.
Not investing sooner
Many young individuals feel that their late 20s and early 30s is the time to enjoy life and not bother about retirement planning and their future. But one must realize that it is never too late to start investing and save for the future. By investing earlier in life, you allow the power of compounding to work its magic for an even longer period of time, thus growing your money to huge multiples.
For example, let’s say three individuals aged : 30 years, 40 years and 50 years want to start investing Rs. 1,80,000 annually (Rs. 15,000 every month) in an equity mutual fund scheme. Each individual will invest till their retirement (at age 60 years), and are expecting a return of 12% CAGR. Their retirement fund will look like :
| Age | Investment Time Horizon | Annual Investment | Expected Rate of Return | Retirement Corpus |
|---|---|---|---|---|
| 30 | 30 years | Rs. 1,80,000 | 12% CAGR | Rs. 5,29,48,707 |
| 40 | 20 years | Rs. 1,80,000 | 12% CAGR | Rs. 1,49,87,219 |
| 50 | 10 years | Rs. 1,80,000 | 12% CAGR | Rs. 34,85,086 |
Avoiding Goal Based Financial Planning
Many individuals lean towards ad-hoc investments in mutual fund schemes. These investments are not mapped towards any specific financial goals. It is not an ideal way of investing. When there is a fixed notion or goal of what one wants to do with the set-aside income in the future (after it has seemingly matured), it is called Goal Based Investing.
Goal based investing involves keeping a specific personal goal in mind while choosing the method to invest. Goals help investors stay on the course and keep investors disciplined as they can monitor and track their progress at regular intervals. A set of clear goals helps strategize and dramatically improve budgeting. As a result, investors deal with poor market movements better. Focusing on long-term goals, allows us to be less distracted by short-term volatility and noise.
If you are in your 30s, map your investments to meet your financial goals. You should ideally follow a comprehensive financial plan that involves a combination of an emergency funds, insurance (health and life), goal planning, tax planning, estate planning, budgeting, etc.
Allowing lifestyle creep to occur
Lifestyle creep occurs when an individual’s standard of living improves as their discretionary income rises and former luxuries become new necessities. Lifestyle creep can easily deplete a person’s finances. The best way to combat lifestyle creep is through budgeting and discipline.
A budget is an estimation of incoming and outgoing cash flow over a specified period of time and is usually compiled and evaluated in regular intervals. To track monthly expenses and buy high ticket items without going into debt, budgeting is highly important. Budgeting helps you understand, where your money goes and will help you gain a greater control over your finances.
There are many different budgeting techniques that can be used to prevent lifestyle creep, such as : The 50:30:20 rule, incremental budgeting, activity based budgeting, value proposition budgeting and many more.
Paying off the wrong debt first
If you have outstanding loans and EMIs to pay, it can be hard to know what to tackle first. But financial advisors caution that you should be careful which balance you pay off first.
When working on your debt payoff plan, start by writing down all your balances and their corresponding interest rates. It is usually recommended to tackle your highest interest rate debt first, like credit card bills, then move onto the lower interest rate debts. Paying off your high-interest debt also helps you save in more ways than one.
Often paying off the wrong debt first can cause huge financial losses because of the growing rate of interest on the outstanding debt.
In Conclusion
When you abstain yourself from these financial mistakes and embrace healthy financial habits, the probability of you, achieving your financial goals becomes quite high. Avoiding these mistakes will help you grow financially and help you reach greater heights.
