Stages in Personal Finance – Step by Step Process to Get Control of Your Financial Situation

Indian middle class is growing significantly in the recent past. Lakhs of people from poor and lower middle class are getting into middle class – thanks to rapid economic growth spurred by outsourcing of jobs to India. Though many of them are earning decent income, they are struggling to manage their money properly. Most people are often left empty handed by the end of the month or getting into debt – even the highly educated fail on this count.

If you are one of them, confused on how to start and where to start personal financial planning, this article will help you by providing step by step personal finance process. These steps will help you make better financial moves in your life.

Stage #1: Create annual budget
The first step in your personal financial planning is to understand your spending . You should be aware of your spending by noting/recording every expense you make. Working without a budget usually leaves you confused as your monthly salary seems to disappear by the end of the month, or even earlier, in the third week. When you create a budget, you can understand how much money you have, how much you spent and how much is left.

We can find many articles on the Internet on monthly budgets. But these monthly budgets may not help as we have some variable expenses that vary each month. For instance, your electricity bill may be low in winter, while in summer it may go high. So, money spent on utility bills is variable. Likewise, you may have to spend money on medical expenses, birthday parties, friend’s marriage, etc. You will not make these expenses every month.

So, you need to consider annual budget to see the difference in the amounts you spend in each month. Here is a simple tool for budgeting to understand your spending and actual living expenses – Spending Analysis and Annual Expense Categorization.

Stage #2: Control expenses to match your monthly budget
Once you have created a budget for understanding your spending, you need to live within that budget. You need to live within 70% of your monthly income . Means, you need to get ability to save 30% of your income. You should control expenses to match your monthly budget.

Many people assume that it is not possible, but you can do it by conditioning your mindset. You need to

  • Live frugally – A frugal spends money wisely and doesn’t spend on unnecessary things. You need to live frugally in order to control routine recreational expenses. However, living frugal is not about living miserliness. Read our article difference between miser and frugal.

Every month, set aside a small portion of income for non-monthly expenses. Also, if you get any extra income as incentives or bonus, you need to save this amount for non-monthly expenses like clothes for festivals, consumer electronics, etc. So, it is better to keep a separate bank account for these non-monthly expenses and keep saving.

Stage #3: Plan for insurance
As the income earner, you need to take responsibility of your family. Insurance is an important tool to protect your family’s living condition in your absence. But most people hesitate to spend money on insurance. You just need to pay around Rs 150-300 per year for coverage of Rs 20 lakhs (in case of term insurance). Remember, as a principle or thumb rule you should take insurance equal to seven times your annual income. Initially take insurance for your parents. Later consider insuring (term insurance) for yourself after your marriage.

You should also consider taking accident insurance, as it is the cheapest insurance that covers death, temporary or permanent disability in case of accident. A typical accident insurance will cost less than Rs 100 per month for a sum assured of 10 lakh.

You must also consider taking medical insurance. It helps to pay off your hospital bills in case of injuries, illness, and diseases. For a 25 year old, it costs around Rs 300 per month for a sum assured of 5 lakh.

An important point to note is that never close your insurance policies until you have substantial savings for retirement.

Stage #4: Maintain emergency cash in liquidity
Emergency situations need more money than what you have for monthly budget. They occur once in a while. When these situations arise, many people get into debt. This is common with people who have improper budgets. They are not prepared for unexpected events and they don’t maintain emergency cash.

Your vehicle may need a repair or one of your friends/relatives may get married and you need to buy gifts. These are the unexpected events where you need to spend money. You need to maintain emergency cash in liquidity for such unexpected events.

Start saving for one month of living expenses as emergency cash. Slowly increase this amount and try to maintain six months’ living expenses as emergency cash. Don’t touch this money for anything else.

Stage #5: Save 30% of income for medium-term & long-term goals
Once you save for 6 months’ living expenses for emergency needs, you need to start saving for medium and long-term needs.

  • 20% of monthly income in Recurring Deposit (RD) – You can use this money for short-term needs like kid’s education fee, house renovation, buy a vehicle (bike or a small car). It can also be used as margin money for home loan.
  • 10% of monthly income in Systematic Investment Plan (SIP) – You need to invest in three different fund houses. Consider investing in multi-cap funds (combines large and mid-cap schemes) of diversified equity funds. This is an excellent investment option for long-term. Remember, don’t close SIP when market falls. Do this for atleast ten years and see the difference. Whatever happens you never use your 10% of monthly income allocated for SIP. It is for your future.

The above step by step planning will give you financial stability in your life. Follow this order and see the significant difference. It may be painful for few months, but makes you lead a sensible life with a better financial position. We hope this helps you make personal financial planning perfect.

Take aways :

  • Create annual budget – monthly budgets may not work properly.
  • Control expenses to match your monthly budget – Live within 70% of your monthly income.
  • Plan for insurance – Take insurance equal to seven times your annual income.
  • Maintain emergency cash in liquidity – Keep six months’ living expenses as emergency cash.
  • Save for medium-term & long-term goals – 20% of monthly income in RD and 10% of monthly income in SIP.

1 comment on “Stages in Personal Finance – Step by Step Process to Get Control of Your Financial Situation”

  1. Very informative.