Introduction to Personal Finance

Whether you are planning for your retirement or saving for a car, managing your finances is essential for living a secure life. Personal finance is a frequent evaluation of one's income, financial demands, and allocation of funds towards essential expenses.

The primary objective is to have a comprehensive understanding of your spending so that you may set aside funds for saving and investing.

You and your family should be capable of managing your personal finances without the assistance of a financial counselor. Ultimately, you are the best judge of your family's needs.

Remember, there is a reason why this is called "Personal" finance. It is best kept confidential and handled with care and devotion. If you can perform simple math, you've already won half the battle. The rest of the work is just the application part where you’ll figure what is good and what is not.  

At the end of this module, you will be in a position to do these things –  

• Develop a deeper understanding of financial products and what goes under the hood  

• Set up a financial goal and work towards achieving that

• Identify financial setbacks and address towards correcting them  

Today, we all disregard saving money because the 'amount' of money we aim to save is probably minimal.

Here is some advice: save it, even if it is a small sum. This will have a significant impact on your financial situation.

Let's take a look at the story of three sisters to understand why we should start saving young.

A father had three daughters. On their 20th birthdays, the father promised to pay each of his daughters BDT 50,000/- on their birthdays until they turned 65. They were free to spend this money whatever they pleased.

As a good father, he also advised to his daughters that they invest this money in a promissory note that would pay them a return of 12% compounded annually, with the restriction that they could not retrieve the funds until they turned 65.

Although they were triplets, their perspectives on money and savings were vastly distinct. This is how each daughter spent the money:

The first daughter began investing immediately, on her 20th birthday. She invested the first nine BDT 50K she received in a promissory note, and then spent the remaining BDT 50,000 (from her 28th birthday until her 65th birthday) on frivolous items.

The second daughter initially spent all the money she received. However, on her 28th birthday, she got a little serious. She decided to save the same   amount as her other sister. So she saved 50K from her 28th   birthday till her 36th birthday, and the money she received from 37th to 65th was spent.  

The 3rd sister was a bit casual till her 28th birthday. She spent all the money   she received from her d ad. However, on her 28th birthday, she got a little   serious and decided to invest the 50k cash all the way up to 65 years.

Here is a summary of what each sister did with the money –  

The first sister saved for the first 9 years (between 20^th-36th   birthday) totaling BDT 450,000/-.  

The 2nd sister saved for 9 years (between her 28^th-36th birthday), totaling BDT 450,000/- . 

The 3rd sister started saving from her 28th birthday, but saved all the w ay till her 65th birthday, totaling a sum of BDT 1,900,000/- .

Now, here’s the question – on the 65th birthday, which sister do you think would have saved the most? Remember, once the money gets invested the   promissory note, it gets locked t ill the 65th birthday and do not forget the   promissory note gives a 12% compounded return year on year.  

Pause and think about it for a moment.  

Chances are here is how you’d think about this –  

The first sister saved too little, very early on, so she would not have saved much.  

The 2nd sister again has saved very little very randomly, so she may not have much on her 65th birthday  

The 3rd sister, although started late, has saved quite a b it and continued to   save for the entire duration, hence she must have the highest savings on her 65th birthday.

This is expected as we humans see things in a very linear fashion. Here we equate the future value of our savings to the amount of money saved today.

But there are two other variables at play here – time and return.

So, here are how the numbers stack up for the 3 sister problem, the numbers may put you off guard so hold your breath –  

The 3rd sister saves 19 lac, which grows to a massive 3.05 Crs by the time she turns 65  

The 2nd sister saves 4.5 lac, which grows to an impressive 1.98 Crs by the time she turns 65  

The 1st sister saves 4.5 lac, however, she ends up with a whopping 4.89 Crs by the time she turns 65!  

Are you confused?  

The first and 2nd sister saved similar amounts, but the difference was the amount of time they both gave their money to grow. The first sister gave full 45 years for the investment to grow, but the 2nd   sister gave only 38 years.  See the difference it makes?

This is the reason why you should start saving early on in life.  

The 3rd sister ends up with the 2nd highest corpus, but for to that happen she had to save for a very long time. But please note, this s till does not match up to the 1st sister’s corpus.  

So if you are someone like me, who missed savings during my early days, then the best option we have now is to save for a really long time.  

I hope by now, I’ve convinced you why you need to start saving early. By starting early, you use time to your advantage and it does play a major role.  

Wait for a second – how did I calculate the growth of money for each sister?  

How did I figure sister 1 saved 4.89Cr and sister 2 saved 1.98Cr?  

Well, this is calculated by applying the core concept of ‘Time value of money’. Time value of money is the central theme of personal finance. Hence, for this reason, we need to understand this concept right at the beginning. So in the next chapter, we will discuss time value and its application in more detail.