Financial Misjudgement is very common during the lifetime of an individual. It may be due to ignorance or lack of awareness. The minor financial misjudgement can be corrected easily and does not have a too much financial impact. On the other hand, financial misjudgement in some of the major financial decisions can push you couple of years back financially. Financial awareness is one of the weak areas in India. In some of my posts, i even suggested to include the basics of personal finance in school or college curriculum.
As an individual, we have very limited resources to invest. India’s average savings rate is 30%. Therefore, an individual earning Rs 20,000 can invest Rs 6,000. All the goals in the life both short term and long term are time bound. There is NO GRACE period or Extension available to fulfil these goals. For example, my Kid will join college at the age of 17 years. Therefore, i have a fixed time in hand to fulfil this goal. I can afford a wide margin in financial misjudgement depending on the time left and my income level or savings rate. As you approach near the goal, the margin of financial misjudgement should become NIL. The reason being, i don’t have time to correct the same. If i am 10 years away from my goal, i can still take corrective steps.
On the other hand, people in lower income group should be extra cautious in financial decisions. In absolute terms, the investment amount is low therefore, any financial misjudgement can put more strain on finances compared to the people in higher income group. In other words, people in a higher income group can afford a high margin of financial misjudgement compared to people in a lower income group. The corpus required for financial goals are absolute in nature. The calculations vary from case to case basis. Let’s check out some of the critical financial misjudgement.
Financial Misjudgement – Top 5 that can Cost you Heavily
1. Repayment Capacity:
This is one of the most common and critical financial misjudgement. In simple words, if the NPA’s of the bank are increasing, it implies that borrowers are not able to pay. It indirectly implies that the error of margin was high at borrowers end. As a borrower, if am earning 1L per month and EMI is fixed at 50K. Firstly, i need to access whether i can manage my household expenses in 50K or not. The reason being, the lifestyle of an individual is adjusted with the income level. Higher income means i will spend more and vice versa. If the answer is NO then it is better to avoid any loan to avoid any default.
You can use EMI calculator to check the impact of the loan on your finances. The family support is a must. Secondly, you should do a dummy run for 6 months assuming that you are paying an EMI. In short, try to manage household expenses within 50K for 6 months. If you succeed then only proceed with the loan requirement.
The similar logic also applies for credit card usage i.e. borrow that much you can repay easily. Besides impacting your personal finance, any error in repayment capacity can have a serious impact on creditworthiness. You may not be able to avail any loan or credit facility in future. Therefore, repayment capacity is no 1 in the list of financial misjudgement.
2. Job Change:
You have to be extra careful when you are changing the job. There are multiple factors that may lead to financial misjudgement. The concept of CTC or cost to company is quite misleading in nature. An increase of 20% CTC may mean 0% increase in net take home salary. It also depends on the tax friendly salary structure. In a particular case, i observed that the take home salary at CTC of 30L for one of my client was equal to CTC of 36L of another client. It is due to allowances and perquisites. Therefore, it is important to calculate the net take home salary rather CTC.
The second blunder is when you change the city. Either you shift with family or move alone. In either case, you need to calculate one time expenses and recurring expenses. It is especially critical in case you are moving alone. It increases your recurring expenses. In layman terms, the household expenses will increase. Therefore, you need to calculate whether the increase in salary justifies the increase in household expenses. Most of the people fail to calculate it correctly. This financial misjudgement can cost very heavily in the long term as you cannot change job frequently.
3. Costly Financial Products:
I have discussed this point in earlier posts. The crux of the matter is that you should keep your investment and insurance needs separately. Secondly, you should not buy costly financial products. For example, in life insurance and health insurance, the difference between costliest and cheapest plan for an individual can be as high as 100%. Though it depends on case to case basis. In my case, a term insurance of 1 Cr from private insurance player was available for a premium of Rs 15k p.a. whereas LIC was charging Rs 30k.
Similarly, in mutual funds the expense ratio eats into your returns. It can have a substantial impact on long-term investments and if the difference is too high.
4. Future Requirement:
This is one of the grey areas due to lack of information available in the public domain. As an individual, i cannot calculate and judge how much money i will require for my kids education after 10 years. It is very subjective in nature. Unfortunately if the future requirement is not clear then the planning will be vague. Similarly, the financial requirement for retirement planning is also not clear. If you check with three different certified financial planners, you will get different no’s and it will confuse more.
The best way to calculate is to consider future as present and do the calculations for today. After that assume 6% inflation per year and then arrive at final no. It may not be accurate & you should do this exercise every 3 years to fine tune your goals. The inflation for health requirement / medical needs will be 15% plus. The inflation for each domain is different. You can take 6% if you are calculating on a consolidated basis.
5. Assumptions goes Wrong:
Last but not the least. This exercise will help to make your financial planning fool proof. The entire plan is made on certain assumptions. Mostly, these assumptions are in the back of the mind. For example, 5 years back all my financial planning was based on an assumption that i will be salaried throughout life. When i left the job and started consulting the entire planning goes for a toss because i never thought about the same. It was a learning.
It is advisable to make a list of all the assumptions you can think of. Against each assumption, you should mention the plan B i.e. what will be the future course of action if assumption goes wrong. This point is not a direct financial misjudgement but an oversight. It can upset your entire plan, therefore, will indirectly impact you. It is an indirect financial misjudgement.
Words of Wisdom: It’s a known fact that life is uncertain. Any financial misjudgement can further increase this uncertainty. Though you cannot make 100% fool proof plan. You should fix a margin of error at 10%. If it goes beyond that then it requires serious introspection.
Copyright © Nitin Bhatia. All Rights Reserved.
Manage better go easy.
Since you have written in repayment capacity about NPA’s, I would like to ask this question. Why NPA’s of the bank are increasing? I dont think a common man can escape without paying EMI for housing loan and reside in that property.
I agree therefore no of auction properties are increasing. It is vicious cycle.
Have you shared anything over the comparison on various demat account based on their services and cost?
Not exactly but i will prefer discount broker like Zerodha.
Thanks Nitin.