Financial Discipline for all.

Principle 12. Lending money to friends and relatives.


“Be careful about lending friend money. It may damage his memory.” ~ unknown.

It’s difficult to watch your friends or relatives struggling financially. If you’re well off and good at heart, you might want to reach out to them as well. There’s nothing wrong to lend a helping hand. Infact, we are supposed to help them in whatever way you can. That’s helping – quite different from lending. When you help them with an amount, you don’t expect it back. It could be a small amount. It’s ok if you don’t get it back.

But lending is different. You lend money when your friend or relative officially asks for some money, stating a purpose and with a repayment term loosely said ‘I will return it as soon as possible’.

What happens in such situations is that you will be held up in a dilemma-

  • It would be difficult to say ‘no’ given the depth of relationship between you guys
  • It would be difficult to ask for a written agreement.
  • If you are good in finance, you may also have a calculation of the interest that might be lost at the back of your mind
  • Since the repayment terms says ‘as soon as possible’ and not a definite date, practically it could prolong for an indefinite time and you may feel very awkward to remind him about your money.
  • If you don’t help him, you might just lose that relation also.

It’s actually a trap. If you have lend money like that, you have only two solutions left –

  • Politely ask back the money indirectly.
  • Write it off !

HERE’S SOME TIPS

Remember, it is your money. Whether you decide to lend the money is up to you. Here are some tips that will help you take a decision to lend or not.

  • Ask your friend why he needs so much of money? If he cannot give a genuine answer immediately, he’s hiding something fro you.
  • Watch what he is answering! if he needs fund for a medical emergency, consider helping him. But if he needs funds to pay off another person from whom he has borrowed money or to settle some financial deals which you find is not proper, you need to think twice.
  • Think about how he has dealt with money in the past. Is he a reckless spender? Is he constantly in a debt trap? What has he done with his salary so far? Does he party all night and lives a lavish life ? If you are not comfortable with his life style and attitude, stay off. Politely say that you can’t lend him money.
  • If he asks for a huge sum which you cannot afford, say no immediately. Also if he’s asking funds because he knows that you’ve got a loan from elese where, do not lend.
  • Remind him about the money, just before the due date. Politely say that you’ll need the funds very soon. I case he couldn’t make the payment on that day, ask him when you can expect the payment. Let him say a date. Also let him explain the reasons why he couldn’t give you the payment as promised.
  • Based on what he has explained, set another date and time and tell him that he cannot miss the date this time. Always keep your cool and never let show any frustration. Keep a broad smile on your face while asking back your money. There should not  be any mistake from your part.
  • Visit his home. Indirectly tell his parents / siblings / spouse that there’s some money deal between you and him. That would automatically create pressure on him.
  • If you really want your money back, keep pressuring indirectly but at the same time never utter a rough word or show a frustrated expression. Once he gives your money back, it’s possible that you guys may not be friends any more. Carefully think if this situation is going to have any negative impact – at work place or between other friends.

CONCLUSION.

Experts warn that loans given to friends or relatives ca lead to strained relationships.

With the following words, we sum up our advice about lending money to your friends / relatives:

  • If you can afford to lose a friend, go after your money ;
  • if you can afford to lose your money , lend as much as you can ;
  • if you cannot lose both, try to strike the golden mean !”

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Principle 11. Utilize credit cards wisely.

CREDIT CARDS

Technically speaking, a credit card is an unsecured loan – a very dangerous instrument if used recklessly. It is issued based on your income. The concept behind it is very simple – you can purchase goods or dine in a restaurant without making immediate payment. The bank would make the payment for you and will allow a credit period of 30 or 40 days to clear it back to the bank. As long as you utilize this credit facility very cleverly, there’s no problem. In fact, it’s like getting a temporary loan without any interest. If you can pay the amount due on it within the credit period mentioned, it’s free money.  But that’s where the benefit ends.

THEN, WHAT’S THE TRAP?

The first trap is that it will tempt you to shop more. Most of the credit card bills will also contain a list of offers that’s too tempting. For example my latest credit card statement has a shopping broacher attached to it in which I am offered an interest fee facility to buy a smart phone at a particular rate mentioned in the broacher.  I can pay back in six equal installments. It’s natural for youngster’s to get tempted on such offers.

The second trap is that the statement will exhibit an amount called ‘minimum due’ which if paid at the right time, will keep you out from the list of credit card defaulters. Hence, after overspending, just in case you could not pay back the amount, you can still survive by paying just the minimum due which would be lesser than 10% of the amount outstanding! For example if your dues are 35,000 your minimum due would be around 1,750 only! You may get an impression that this amount consists of interest and some portion of principal but, actually, this amount is fully charges as interest. That’s effectively 60% interest per annum. That’s why it’s such a killer.

Trap three- it gives you the facility to withdraw cash from any ATM counter. The moment you do that, you’re billed 1.5% or 2% of the amount withdrawn as ‘processing fee’ and the interest is charged on the amount withdrawn plus the processing fee. For example if you withdraw 10,000 you will have to pay back 10,150 with interest on it till repayment. There is no interest free credit period for cash withdrawals. It’s only for purchases.

Trap four- You will be tempted to do a lot of online shopping. There are hundreds and thousands of online shopping websites now. Online purchases require your credit card number to be disclosed. If such datas are not transmitted through a secured system, it may reach fraudsters who will mis-utilize your credit facilities. Finally you’ll end up responsible for the dues they make. Online purchases an be made only through trusted websites which has visa approval.

Trap five – If you have overdues on credit cards, that is, if you fail to make at least the minimum due on the card, that going to cost you even higher. Once a credit default is made, you will be slapped a fine of 250 or 500 plus a higher rate of interest. From there on your liability will skyrocket if not cleared immediately.

Credit cards are like boomerangs. If you know to handle it, it will give you results. If used recklessly, it might just come back and hit your face.

The thumb rule is simple –

  • First know when the credit cycle starts. ( say 1st of every month)
  • Then know your credit period (say 30 days).
  • Utilize those thirty days interest free. That is, do all the shopping in the first week itself. If you purchase something on 25th, all you have is 5 more days left
  • Always keep track of your credit limit and make sure you never cross that limit. Once you cross the limit, you free credit period ends there and the money becomes payable immediately.

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Principle 10. Have a Monthly budget

You plan to fail, when you fail to plan .

WHAT IS A BUDGET?

Budget is a careful allocation of your monthly income.  Based on a study of your income, present expenses and future plans, a set of spending rules are identified. You spend your money only according to the pre-decided rules. The idea is to control expenses and make a surplus so that you financial goals are achieved.

HOW TO MAKE A BUDGET?
Budget is vital in keeping your finance in order. Before you begin to create your budget, it is important to list out all your sources of income and expenses separately. Here’s a step by step general guideline to make a good budget.

Step 1. Write down your sources of income

The first step is to write down all your sources of income. Apart from salary or business income do have any other sources like rent or agricultural income? Have fixed deposits? Remember to include all such sources of income.

Step 2. Set aside a sum for income tax.

You cannot start dividing your money straight away. The first and foremost thing to understand is that whatever income you earn, you are liable to pay tax to the government. That’s mandatory everywhere. Some of you may get income only after deduction tax. Depending upon your expected tax liability, you are supposed to set aside an amount to meet the tax commitments.

Tip: if you can consult a tax practitioner, he will tell you the exact amount of tax!

Step 3. Make a list of fixed commitments.

Once you have computed your total income after tax, the next step is to find out your monthly fixed commitments. Fixed commitments include your monthly rent, school fees for children, EMIs, SIPs etc.. These are expenses that stay the same every month and you cannot bring it down by adopting any cost cutting measures. First deduct the total of fixed commitments from the amount you computed in step 2.

Now, what’s the balance left?

For example, you have a monthly income of 50,000 from which you have to pay a tax of 10% which is 5,000. you find that your monthly fixed commitments works out to 28,000. So, 17,000 (45,000 – 28,000) is the balance left with you. This is the amount which is absolutely in your control. You can save it or spend it!

Step 4. Variable commitments

Step 2 minus step 3 gives you a clear idea about how much you can spend on variable expenses. Variable expenses are those on which you have absolute control. Expenses on Items such as entertainment, eating out, gifts etc are variable. It depends on how effectively you control it. It is in this category of expenses that you make all the adjustments.

For example, if you have decided to subscribe for one more Systematic investment plan, you need to cut down and find money from your variable expenses part.

HOW TO TRACK YOUR BUDGET.

  • Total your monthly income and monthly fixed expense and monthly variable expenses and see if your income is more than your expenses. If yes, you’re doing well.  The surplus can be used to pre-pay your loan commitments as soon as possible.
  • However, If your expenses are higher than income, that’s an alert sign. In this case, you’ll have to control your expenses. If you have some surplus cash left, try to pre-close your loans to the maximum extent possible so that your fixed expenses part can be reduced to that extent. That step may be a bit difficult to do since it involves cash outflow. But, you can definitely control your variable expenses part.
  • A budget once drawn will not remain fixed for ever. It may have to be re-drawn when your income or fixed expenses part has a change in it.
  • Good financial budget planning should include provision for emergency funds. It’s better to include the emergency fund in your fixed expenses. Because it is very important to have some money in the bank in case you need it for something unexpected such as a medical treatment.
  • Just in case you had to spend a little more than your budget this month, make sure you cut back your expenses in the following month and compensate for the overspending.
  • Instead of writing budgets on paper, it will be more convenient to use a spreadsheet like excel where you can easily add or subtract or mike any corrections.  Corrections are possible without much fuss and you can also easily plot a variety of different graphs to clearly see things visually.

CONCLUSION.

What’s said above are very simple steps. We all do budgeting to a certain extend every month through mental calculations, although unsystematically. If you are not budgeting you will never know how your income vaporized.

That’s principle number 10 for you !!

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Principle 9. You are not safe with fixed deposits alone.

Principle 9 is in fact, a continuation of our earlier post on inflation. The reason why we are posting it separately is because there is a certain section of people who think that they are financially safe if they have a regular income from bank deposits or debt instruments. This way of ‘Generating income’ is so popular. World over, people think that if they have a considerable amount in fixed deposits or debt instruments, they are safe. That’s not the real picture. You earn money only if your investment can generate a post tax income which is greater than the average combined rate of inflation and tax prevailing in the country you are living. We will explain that:

Let’s take the example of Mr. A who lives in India:

  • He invests 200,000 in Fixed deposits for 8% interest and gets 16,000 as interest at the end of year 1.
  • But effectively, he would get an amount lesser than 16,000. That’s because of two factors: 1) Income Tax.   2)  Inflation.
  • Assuming that the bank deducts 10% as tax , Mr. A will get only 14,400.00 as interest.
  • Now, the second factor that reduces your income is Inflation.The average inflation rate in India is around 8%.
  • That means, your 214,400 is further reduced by 8% in value at the end of year 1.
  • So your 214,400 gets effectively reduced to 198,518
  • By depositing your money for 8% interest, you dint actually earn anything. in fact you lost 1482 from your capital

Hence if you have all your money in debt instruments like fixed deposits, you’re not safe. You principal amount would keep reducing in value over time. So, the point here is that, you have to look for investment opportunities where you can generate an income that is higher than the combined rate of tax and inflation.

How to check:

Step 1. Multiply the money invest with the rate of interest offered.

Step 2. From the interest amount received in step 1, deduct the applicable tax.

Step 3. Find out the average rate of inflation prevailing in your country ( search in Google, it’s just a click away)

Step 4. Apply the rate to the amount received after step 2 and find the present value.
( how to find present value has been already explained in our earlier posts)

Yes ! It’s time to think smart. You should look at instruments that can at least cover you against inflation and tax.

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