How to do goal based investing

How to do goal based investing

Setting up a goal is something that no one does these days. I am asking you all to set a financial goal.

Every time I ask someone – Why are you investing? What is the purpose of your investment? 90% people will answer to grow my surplus money.

I have money lying in my bank account. I am just spending too much. I thought it was time to start investing.

My next question is ‘for what do you want to grow your money?’ Their answer is to become rich or help in a financial need or to travel. Travel is a more focused goal but becoming rich? Isn’t everyone working to become richer than what they are today?

In cases, where your goal is more focused and clear, you will be in a better position to achieve it than your investments where it is not.

When you know where you are going, you are halfway there.

I know it is extremely difficult to sit with a pen and paper and jot down your financial goals. However, the difficulty of the process does not reduce the importance of the same.

I have listed below a step by step process of identifying your goals, requirements, money that you need and the products into which you must invest to achieve your goals.

What do you want to achieve in life?

I am sure you have been asked this question by various people ‘What do you want to be when you grow up? Where do you see yourself in 5 years? What do you want to do in life?’ These are all your various goals that people want to know.

What are the things that require money to be achieved – i.e. financial goals?

Yes. All goals need money but all goals are not financial goals. Wanting a promotion at work, Best in your field, learn a new hobby or activity are all personal and professional goals which does not require too much investment or any investment of money from your end.

Owning a house, traveling to Europe, buying that car, your child’s post-graduation are some examples of goals which require a huge investment of money from your end and are called financial goals.

Hence, make a list of all your goals and from that highlight your financial goals.

Prioritise your goals - difference between Need and Wants?

It is very important to prioritise your goals based on its importance and requirement.

Needs are such things that you cannot do without and cannot be canceled, such as your child’s education or your first house.

Wants are things which you desire but can do without them such as a vacation, your second home etc.

Segregating your goals into needs and wants will help you prioritise them better. All the needs can them be numbered based on their importance followed by your wants.

How much money do I need today to achieve these goals?

Once you have made an entire list of your goals and sequenced them, you must identify what is the cost of achieving those goals. For example, if your goal is to buy a car, you must identify which car you want and how much would it cost. 'I want to buy a car like I20 and it would cost me 7 lakhs INR today' - this a well-defined financial goal.

Where you are estimating the cost of goal because you do not have an exact basis to calculate it, always consider the amount on the higher side.

By when should I achieve these goals?

The fact that it is a goal, it means it is futuristic and you do not have sufficient means to achieve it today. Hence, you must identify and apportion a realistic timeline towards your goal.

For example, I want to buy a car in next 2 years.

Goals less than 5 years: Short-term goals
Goals between 5 years to 10 years: medium-term goals
Goals more than 10 years: long-term goals

Adjust the Inflation

Given that goals are a futuristic, the current cost that we have associated to our goals will obviously increase in the future because of inflation. Identify the inflation rate towards your goal. The inflation rate is not the same for all types of goals; it varies depending upon the market conditions and the goal.

After knowing the inflation rate and the current cost, you will be able to compute the future value of your goal.

It is very important to identify the correct inflation rate. If you take a lower inflation rate your goal will cost you more than what you estimate and if you take a higher inflation rate, the future cost may scare or reduce your confidence to be able to achieve the goal.

Asset allocation based on the goal, cost, and tenure

Once you know your goal and its value, it is time to identify the investment products.

The tenure of your goals will help you to identify what asset class you must invest in and in what ratio.

The term is less than 5 years – 100% Debt
The term is 5 years to 10 years – 40% Debt 60% Equity
The term is more than 10 years – 30% Debt 70% Equity

This is a very general method of asset allocation. It may vary depending on your risk taking capacity and ability. Hence, it is important to analyze the same for oneself.

Portfolio Return Expectations

Return expectation from each class of the asset is as follows:

Equity: 12%
Debt: 8%

You will have to invest money in your goals based on the tenure and asset allocation. Each goal will not have one investment but may consist of many investments some in equity and others in debt. Hence, it is important to compute the return expectations for the entire portfolio, to be able to compute the exact amount you must invest to achieve your goals.

For example, my goal of buying a car is a mid-term goal, my asset allocation will be 40:60.

My portfolio return will be (40% * 8%) + (60% *12%) = 11.2%

How much money to invest?

This is the most crucial part, the entire computation of the above working will lead to identifying how much money you need to invest to achieve your goals.

There are various ways of investing but it is better to do it in a systematic manner. You can invest as a monthly fixed investment amount or invest annually with a fixed percentage of investment increasing per annum.

SIP - 7900 per month invested for 7 years will give you a return of 10,14,000 @11.2 %.

Lumpsum-

This method can be a bit complicated when followed step by step especially the last step of computing the actual amount that one needs to invest to achieve their respective goals. However, it is the most defined way of achieving your goals. There are many software used by us - financial advisors where the software does the same calculation for us. When you will sit with an honest financial advisor, the first thing that they will ask you is to define the goal. There is no plan without a goal and hence, such a working is extremely important for your financial planning.

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Why you should not buy financial products from your banker?

The simplest answer to this question is that, more often than not, the banker is more interested in the product than he is interested in you. To illustrate this better, we have discussed a few examples below: Say you have been a customer of a particular bank from 2008 tillBelow is what you would have typically experienced over this period of time. Your first job, 2010: Sir, along with your salary account, we are offering you a credit card, free of cost. There will be no annual charges and you can enjoy a credit limit of INR 50,000. Along with this we are offering you this "Investment product" which gives higher than market returns, especially for our customers. To make it easy for you, you can pay the yearly premium in 12 equal interest free installments using the credit card. (With this, he introduces you to the world of credit cards plus has latched you on to an investment product mostly a ULIP product (link on ULIP article) without you properly understanding the product. What he doesn't tell you is the charges involved in delayed payments on the credit card, neither does he guide you as to how you can be a disciplined credit card user!) 2008, with the markets soaring or currently when the markets are doing very well: "Sir, XYZ Mutual Fund has come out with a New Fund Offer (NFO). The new Fund promises very good returns since they are focusing on the Infrastructure theme which will give very high returns over the next few years." "Sir, ABC Mutual Fund has come out with a New Fund Offer (NFO). The new Fund promises very good returns since they have a "new strategy" where they will identify "superior growth" stocks and generate superior returns." (What he doesn't tell you is the risks involved in investing in equities and that he is selling you a product which doesn't have any track record of good returns!)

Immediately after the 2008 crash: A period of silence from your banker. Obviously, he doesn't want to bring up the returns from the ULIPs and NFOs he sold to you earlier in the year! 2009, post ban of entry loads on MFs: Sir, this is a unique investment product. It not only gives you high returns by investing in Equities, it also gives you an insurance cover. (What he doesn't tell you is that ULIPs hardly take care of your insurance requirements. Neither does he elaborate on the various charges on the ULIP products!) 2010, post reduction in commissions on ULIPs: Sir, you should invest in this product. If you invest INR 25,000 per year you will get INR 13,70,000 tax free after 25 years and also an insurance cover of INR 10,00,000. (What he doesn't tell you is that the rate of return is a partly 6%!) I guess many of you (irrespective of your age group!) will be able to relate to the above experience. It clearly demonstrates that your banker is more interested in selling the product that earns him the maximum returns with no consideration to what is the right product for you. He sees the immediate short term benefits for himself from the sales made to you. Why think like your banker and look at the short term? Think long term. Hire a Financial Planner, pay him a fee to give you the right advice and invest in the right investment product. Over a period of time, the benefits from investing in the right financial product far exceed the fees you pay your Financial Planner. Again, think long term. Educate yourself! It is very important in today's time, when there is a pool of information everywhere but no good data, learn and understand and take an informed decision, rather than just following someone blindly. It is your money, if you will not treat it right, why would a banker do that. PS: There can be exceptions to the above kind of bankers. But, more often than not, the story is the same everywhere.

Money tips - 10/27/2018

The trap of cash back offers

Recently, while booking my flight tickets through one of the travel booking websites, I saw this “100% cash-book offer “flashing on my laptop screen. I got super excited, 100% cash back means the entire flight ticket would be for free. Who would not use this offer? I immediately registered on the mobile e-wallet and made the payment through the same. However, after making the payments, when I started to book my return flight tickets with the cash back I got, I realized that I had done a grave mistake of not noticing the tiny ‘*’ and thus, not reading the conditions specified in fine print below the offer. Following unfortunate events happened after I made the payment using mobile e-wallets:

The offer was a 100% cash back offer of only the base price of the flight ticket and not the entire amount I spent on buying that ticket. So where my total cost including charges and taxes was INR 4200. I only got a cashback of INR 2700.
This is not that bad right; I got almost 70% cash back which is still an amazing deal. To make most of the cash back, I decided to book my return tickets using the wallet cash back. I was still happy because if not 100% I did get a 70% discount on my flight bookings.
While making the payment, after I had put the mobile wallet details, the system asked me for my bank details for balance payments. How could this be possible? My return flight ticket was worth INR 2500 and my wallet had a balance of INR 2700. Why is the travel website ask for my bank details as well?
After a little more '*' reading, I realised I had missed on another fine print. It stated that I could only use 15% of the cost of each purchase from the cash back balance in my mobile wallet. Thus, only INR 450 would be paid through the mobile wallet, balance INR 2550 had to be paid separately.
I declared that this was outright FRAUD and I am now a victim of cash back offers from MOBILE WALLET Company.

Cash-back offers; Discount; Sale - Are we really saving money through these?

Are we all actually benefiting from the cash back offers and these discounts? Some of you may say whatever is the discount, it is still a discount. The cash back appears to be like it is reducing my expenses but it actually makes us spend more, worry more and definitely, calculate more on every rupee spent. I have discussed the same below: Spend more than required: My flight cash back seemed like a decent discount inspite the restrictive clause of using it. To make the most of it, I had to do make next few purchases through the mobile wallets. Hence, I decided to shop for my upcoming trip. I shopped for things like shampoo, body wash etc which I did not specifically need for my trip but was buying to exhaust my cash back. This wallet did not work on so many regular e-commerce websites that it was a struggle to make the most of it.

I just spend on things I did not need to utilise my cash back. This is what cashback offers do to you, it makes you spend more than required so that you can benefit completely from the cash backs received. It becomes your personal loyalty programme.

Limited Validity: Most of the cash back offers come with a validity period. I had to utilize the cash back in my mobile e-wallet within a fixed period of 6 months and to utilize the same, I ended up ordering daily use unnecessary items in advance. Inspite of this, after 4 months, I gave up on this regular hassle and ignored a cash back of INR. 1100 lying in my mobile wallet. The effort, time and unnecessary small purchases that I made to utilise the cashback were not worth the money that I wanted to save. Like me, many people are falling into the traps of the mobile wallets and cash back offers. Such cash back offers are also provided by various credit cards which makes us shop for that one extra shirt or dress so we can cross the specified limit to get the cash back in our credit card. If you get a 5% cash back on a purchase of INR. 5000 it is Rs. 250. You might end up shopping for lot more than the cash back just to get that cashback. Cash Back offers are a loyalty programme: The trap of cash back offers is not direct. As stated above, cash back offers are like a loyalty programme. It generally makes consumers spend more than we want by convincing us that we are getting more benefits out of it. Cashback works as a nuclear reaction making us purchase continuously. Usually, we end up spending more compared to the cases where there are upfront direct discounts or no discounts at all eroding the cash back completely. It is very important to know that none of the financial institutions including mobile wallets, credit card companies, banks, etc are doing charity or customer support in any form. Any discount or cash back is what they can recover from us easily. Nothing in life is for free, when anything is for free or at a discount, you are the product. Thus, we should be wise enough to understand where we are getting a discount and make most of it rather than falling prey to unnecessary cash back traps. I hope next time you see that cash back flashing on your screen, you will take a more informed decision.

Money tips - 10/23/2018

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To buy or not to buy

To buy or not to buy is an old story. The new story is to be this or that. We are definitely spending on one thing or another. It is not that we are not spending at all. The only thing we as a consumer are doing is deciding whether to buy this or that. Some of us do not even do that, we just end up buying everything because of our 2 best shopping companions’ credit cards and EMIs. People have stopped justifying their expenses and this is the reason why there are not enough savings and thus, reduced investments. You can save only when you spend less and thus, I have dedicated this article on how and where we spend extra and how can we control our spending.

Buying on Impulse – This would be the most common way of going off-budget. Have you bought something and then realized that you don’t enjoy it anymore or you aren’t as excited about it as you were at the time of buying it. It is very common to do the same, especially when you are not feeling very good, you see your neighbour own something that you always wanted. To avoid this, don’t buy something that you like when you see due to certain emotions/influences immediately. Go back. Sleep overnight on that purchase. If next morning you wish to own it, go back and then buy it.
Carrying credit card balance – Using a credit card to buy the new laptop, phone or even those expensive shoes online. Having that credit card balance has become the way of life for most of us where consumer credit is so easily available. The problem arises when it is used for regular purchases. Paying interest as a failure to pay off credit card bills makes the prices of the charged items a great deal more expensive. We have written it in detail in our Article - Why you must avoid credit cards.
Avoid paying bills on time – Have you ever missed paying your telephone bills or other utility bills at home? In this time of auto debit/email reminders/ Paytm reminders, it is still so surprising that so many people with balances in their bank accounts forget to pay their bills on time and are completely ok with doing the same. For instance, if you have 4 credit cards and you are not clearing the minimum dues on time, you would be paying at least Rs. 2,000 in late charges alone. However, if the same amount is invested every month in a scheme that earns, say 10% annually, it can actually fetch you 32 lakhs in 25 years.
Spending by habit: Quite often a lot of our spending is a daily habit, which could be unnecessary too. For example, if you buy a takeaway coffee every day for your office staff/visitors why not invest in a coffee machine? Re-evaluate your habitual spending patterns and decide whether that is necessary.

Having unused memberships/subscriptions – Everyone has an account on Netflix, Hotstar, Amazon Prime, Voot TV, the unlimited data pack, household cable with HD. All of this totals to around 2000 INR per month. The same is equivalent to Rs. 24,000 per annum. Do you have enough time and resources to go online and watch movies on all of them? A person on average is spending 24,000 per annum for his entertainment solely through online channels. I have not even considered the money spent on theatres and other modes of entertainment. Gym memberships are other classic examples of unused memberships.
Paying for unnecessary services/charges – When a seller is selling something new in the market, it is their job to create a requirement for their products but it is up to a consumer to judge sensibly if they actually need that product or service. You may sometimes need a car helpline service, but why to go for the extended warranty on a car or washing machine when that is hardly worth the price? Do you also really need all those extra features for your cell phone?
Not having clear needs in mind: People tend to overspend when they don’t have a clear objective of what they need to buy. Thus, they often end up buying things just because they ‘look nice’ and not because they are actually needed. Therefore, avoid getting inside a mall without a clear objective. Window shopping has put most of us into huge debts or low cash balances.
Living beyond one’s means – The availability of car loans to buy the first cars or easy access to credit cards can tempt anyone to indulge in buying things even without being able to afford the expense. But just because you own a credit card, it does not mean you should indulge in whatever you fancy at the moment.

Being ignorant of one’s spending – Ignorance is bliss? Think again! “Many chronic shopaholics live in denial about how much they spend. If you realize how much you spend on various items, this alone may be sufficient to reduce your spending.

Money tips - 08/28/2018

Common Nomination Mistakes that you must avoid

We have listed below the common nomination mistakes that people make and how should one avoid making them. Not informing the nominee –This may sound very basic but at many families, the wives and children are not involved in the financial matters of the house. Not informing the nominee about his/ her nomination and the details of the policy is a major mistake that you can do as a policyholder. The insurance policy is taken to secure your dependents and if they are not informed of the same, it does not serve its purpose. Generally, the insured is reluctant to inform the nominee because of insecurity or just carelessness. Such an ignorance will deprive the family members of the financial support that they would receive from the policy. Not updating nominee details –This is due to laziness and ignorance. Avoiding to update details is as good as not nominating someone. Another problem is not revising/updating the details of the nominee periodically like his address, age (minor to adult), status etc. If the nominee dies before the policyholder, it is very important to change the nominee details immediately. The policyholder has the right to change the nominee and his/her details any number of times during the term of the policy. Appointing Just One Nominee -Generally while entering details in the policy form, many of us mention just one nominee even after having more names in mind. It can be because people do not know they can nominate more than 1 person. Where the nominee dies before the policyholder and the details are left unchanged, there can be severe delays and rejection in receiving the claim money. As a policyholder, you must state more than one name in the nominee column with some defined percentage or the order in which the nominee should receive money. Remember to enter genuine details like full name, address, and relationships with the insured. You can also appoint successive nominees in your insurance document. This is considered the most advisable method of nominating. Appointing a nominee under 18 without an appointee –Prefer a major person instead of a minor so that one does not require having any appointee in such a case. If there are circumstances where it is compulsory to mention a minor as a nominee then it is advised to offer genuine and complete details of the appointee which includes his / her name, address, relationship with nominee etc. And the appointee is in charge of the minor until he/ she turns 18. Having Wrong Notions About Nominee Rights : Most of the people have a preconceived notion that a nominee has absolute rights. This is not true. If the nominee and the person to whom proceedings are bequeathed in a Will are not same, then a priority is given to the provisions of the Will over the rights of the nominee. In case a policyholder wants to give absolute rights to his/her nominee, he needs to prepare a Will and mention the beneficiaries thereof. It’s better to be cautious and have clarity on these matters in advance to assure financial protection of your loved ones.

Money tips - 08/24/2018

Why should you draft a will?

There are many individuals who have made appropriate investments for their family’s well-being, insured their life with a term-insurance rather than an endowment plan etc. However, they are wary of writing a will or feel that they should write a will after they cross a certain age.

I discussed with my parents and was trying to reason with them on writing a will. I even offered them to keep it anonymous and get a third party lawyer involved. In spite of the same, they were not very convinced on writing a will. The root cause of this problem is our ancestors and our previous generations who have been very conservative and conscious about their family wealth. They never wrote wills as they were scared that their children will not take care of them in their old age. The same mentality may be passed on to some individuals today. However, we must have faith that we are better than that and our in better financial position than our ancestors.

Making Nominations & Its limitations

This is the simplest way of ensuring that one’s assets i.e. saving accounts, fixed deposits, provident fund etc. are transferred to your dependents at no additional cost. However, it is very important to review your nominations from time to time as your relationships keep changing. You may want to edit your nominations when you get married, when you have children and when your parents/others (who are nominated are no longer alive) etc.

There are a few limitations/conditions to note in case of nominations

If a nominee is a minor, you need to assign a suitable guardian.
Any change in nomination necessities a witness
A nomination is held good only in the absence of a valid contrary claim by another person.
If the nomination is challenged by will that disposes of assets in a contrary manner, the nomination will be rendered ineffective.
Also, if the person dies intestate (without a will), the laws of succession will override the nomination.

Start working on your will

Limitations of the nomination process increase the need for a will. If you want a conflict-free distribution of assets amongst your dependents than you must write a will.

People still believe that will is for the affluent. A will should be written by all those who have certain moveable and immoveable assets and also, want a peaceful distribution of the same among their children and dependents.

Estate Planning

Another method of distributing your property amongst the heir could be estate planning. Financial planners and wealth managers help you in valuing your estate and completing other formalities. It involves amassing and disposing of the assets to ensure that the end goals of the owner are met after his/her death.

Advice is given on the basis of valuation of the assets for the purpose of the division amongst multiple heirs. The applicable laws of the land (and religion of the individual) with respect to succession are also taken into account.

It also includes tax planning to ensure minimum outgo of tax at the time of transfer to the beneficiary.

Writing a will is also a part of the estate planning process. You may also choose to form a trust in case the beneficiaries are minor children or charitable organizations.

The difference between a will and a trust is that while a will can be implemented only after following the requisite legal procedures whereas the trust can transfer the property to the beneficiary immediately after the testator’s death.

Money tips - 08/21/2018

Nomination process in case of life insurance

You are buying life insurance to secure the financial life of your dependents. To avoid your financial dependents of any troubles you must ensure that you have bought a cover of the adequate amount, disclosed all the correct details and informed your dependents about you having a term Insurance.

Have you nominated your dependents in your life insurance or you thought that you shall do the same eventually?

What is Nomination?

Nomination is a right given to the life insurance policyholder to appoint a person or persons to receive the benefit under the policy in case it becomes a death claim. Assume if a person who is insured dies, the nominee is entitled to receive the policy proceeds subject to certain conditions.

Meaning of a nominee as per the earlier laws

Earlier, the nominee in your insurance policy would not in actual receive and benefit from the insurance money but was to act as a trustee of the claim amount he or she would receive from the death claim.

Acting as a trustee means that the nominee had to distribute the claim amount as per the legal heir rules or the WILL of the deceased person.

Hence, earlier nomination meant not an ownership of claim amount. This lead to many legal battles between nominees and legal heirs to claim the death claim amount of the insured person.

What is the meaning of Beneficial Nominee in your Life Insurance?

IRDA introduced the concept of Beneficial Nominee.

Now as per the new rules, suppose you nominate your parents (sibling is not included), spouse or children, then they will be considered as the beneficial nominee and the death claim amount will be payable to ONLY them.

Other legal heirs as per the will or otherwise cannot claim the death claim amount. Accordingly, Life Insurance Company will pay the death claim benefit ONLY to the nominees.

Hence, while buying a life insurance, you must have a clarity of mind as to whom do you want the death claim amount to be payable in your absence. The nominee also has the right on the claim money if the policyholder dies after the policy period is over but before receiving the maturity benefited.

Things to keep in mind while assigning your nominee

You as the policyholder can declare the nominee at the time of policy application, or at any time later during the term of the policy.
You can nominate anyone as a nominee – your spouse, your children, relatives, your friends, unrelated people, anyone. You need to provide details such as full name (as per the nominee’s documents), gender, address, age and the relationship between the nominee and you (if there is one).
Suppose you nominated your friend or someone who has no insurable interest in your life, then such non-relative will not be treated as the beneficial nominee. In such a situation, your actual beneficial nominees or legal heirs can prove that he or she is not a beneficial nominee and can get the claim amount from the nominated person.
A valid WILL still can negate the rights of beneficial owner and money can be disbursed according to the WILL of the insured.
The nominees’ details are generally printed or endorsed on the policy certificate. If such information is not available on policy document, then the nomination is not valid.
Change or cancel nomination for INR 100 for each change.

Types of nomination permitted or advised

You can also nominate multiple people in a particular ratio, e.g. 40% to person A and 60% to person B.
Even successive/alternate nomination in life insurance is possible. This is nothing but the nomination order. e.g. nominate the money to person A. If he is not alive at the time of claim, it can go to person B. If B is not alive as well, it can go to person C. All the names of A, B and C need to be declared upfront at the time of successive nomination in life insurance. This is the best way to nominate and it is highly recommended.

What if One Makes No Nominations in the Policy

In case your policy fails to have a nominee, you need not worry, as the sum assured will be discharged according to the following rules -
The insurance company might dispatch the claim amount to Class I legal heir which includes- insured’s spouse, son, daughter, and mother.
In case of a Will, the process is followed according to the Indian Succession Act, 1925 where the claim amount is distributed according to what has been stated in the Will. A succession certificate from the court will be required, to have a clarification on whom to handover the claim amount.
Whenever there is more than one legal heir, insurer intents are to safeguard their interest in scenarios of dispute on settlement of the claim. For this, the insurer shall ask for an indemnity bond, joint discharge statement, and waiver of legal evidence.

To learn more - you can check our course - NM 102: Build a Safety Net. Use code SAVE20 for 20% off.

Insurance / Money tips - 08/20/2018

Mental Accounting

If you went to watch a movie and lost the ticket would you buy a new ticket? But if you lost a currency note of INR 500, would u not buy a movie ticket using your debit card? After I came across this Question, I asked almost everyone I met for the next few days to understand if the response of people is the same and what do they think before taking a decision. Most people said that they would not buy a second ticket if they lost the first one, but would borrow/use their debit card to buy the ticket if they lost the INR 500 note kept aside for the ticket. The incidents are basically same; you lose INR 500 on the lost movie ticket or the INR 500 note, the amount lost is the same. The only difference is the way you lose the money but you tend to combine two financial outcomes depending on the perceived benefits from these two outcomes. How does it impact us? Our mind segregates money into different accounts based on the situation we have derived the money from or spent in. Our mind is making different folders to categorize and treat money differently, depending on where it comes from, where it is kept and how it is spent. This process makes us treat money earned through different sources differently, thus, increasing our spending habits. Let me explain this with more relatable examples. In my article on cashback offer is a trap, I had discussed how cash back makes us spend more on things we do not need so that we can utilize the cash back. The reason why we do that is in our minds; we create a separate folder for cash back received and are ok to spend that because we do not treat it as our own money. Whereas, in the case of a direct discount, we just spend less in the first place thus leading to genuine savings. In another article of Insurance frauds, I have discussed how I got duped into buying the wrong insurance product and had to surrender the same after 2 years. I had paid a premium of INR. 120,000 for that insurance but received only INR. 58,000 on surrendering my insurance policy. This money should have gone directly into my investment account as it was already invested money and only then the surrender would have made sense. However, I treated it as a windfall money and ended up spending most of it for shopping, buying a new phone and taking an impromptu trip to Goa. There are many times I have personally lost investment opportunities or incorrectly utilized the money received due to this mental accounting. Some more examples could be treating your bonus income, income-tax refunds, buy-back offers, health insurance claim received (post hospitalization) etc differently than your regular source of income.

Creating mind folders of the money coming in based on its source leads to increased spending.

Leads to slower growth in wealth Mental Accounting is the reason why people continue to earn low-interest rates on fixed deposits in the bank while paying a high rate of interest on their credit card debt or a personal loan, instead of breaking the fixed deposit and repaying the debt. Remember that the interest you earn on your fixed deposit will always be lower than the interest you pay on your credit card debt. We have also discussed how credit cards overspending are an act of mental accounting and how it impacts our spending behavior. We consider the credit card limits or the money used via credit card as different money and buy anything and everything through that without understanding that it is. Refer article Why you must avoid credit cards. How to deal with it Understand that money is fungible. All the money coming in (irrespective of the bank account and source) should be your income and the money going out - your expense. This simple 2-way categorisation can help one deal with their overspending, debt problem and earn higher interest rates through right investments. This is why it is very important to develop the right attitude of managing finance along with the technical skill to understand the various financial products.

Money tips - 08/06/2018

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