The new year brings with it new hopes and new opportunities, and along with it, a promise to make our lives better. Many of us would also make a pledge to give up on some bad habits like smoking or binge eating this new year.
As a matter of fact, this new year could also be a good time to shed some bad money habits which are knowingly or unknowingly damaging our finances.
If one checks the dictionary, the word ‘habit’ means a settled or regular tendency or practice, especially one that is difficult to give up. Habits can be both good as well as bad.
Behavioural finance has a good explanation of habit. It defines a status quo bias which states that people prefer things to stay the same by doing nothing or sticking to a decision made previously.
The same would hold true for money habits as well. It may be difficult to get out of one, but not impossible.
Let us look at five money habits you should try and give up as 2023 rings in.
1] Parking money in savings account: Most people have salary accounts and keep a large chunk of it in the same to meet day-to-day liquidity needs as well as for emergency needs. But that is an inefficient way to park money, as this money is earning you a very low rate of interest.
“I suggest not to park more than 20 per cent of the emergency fund this way,” says Abhishek Kumar, founder and chief investment advisor at SahajMoney, a financial planning firm.
He suggests investing the balance 80 per cent into a mix of liquid and overnight funds. If one doesn’t face any emergency for the next three years and stays invested, then he/she gets two benefits: a) indexation – adjust inflation from the capital gain, and b) lower tax – 20 per cent taxation on long-term capital gain.
2] Considering insurance as an investment: Certain things do not go together. Insurance and investment is one such thing when it comes to finances.
“Despite penetration of other modes of saving instruments in recent decade, many people still use traditional insurance products for protection as well as saving. These insurance products generally provide cover of 10-15 times the annual premium. Ideally though, one should have a life cover of at least 10-15 times their annual income,” says Kumar.
This means if one’s annual earning is say Rs 10 lakh, then he/she should get a cover of Rs 1 crore. The best way to go about this is to buy a term plan and then invest whatever you will be saving by not buying a traditional plan into a mix of diversified portfolio of debt and equity, based on their risk profile.
3] Paying minimum balance on credit card: When it comes to bad money habits, this one sits somewhere at the top.
Credit card companies make money by: a) fees – from users and merchants, and b) interest income – from users who don’t pay full bill at the end of the month. This interest can go as high as 50 per cent annually. So, a credit card outstanding of say Rs 1 lakh by the end of the year becomes Rs 1.5 lakh.
“So instead of paying just the minimum balance on the card every month, pay off the entire outstanding due. If you don’t have sufficient funds in your savings account, then liquidate some of your savings, in say, fixed deposit or debt funds to pay it off,” says Kumar.
In case you cannot pay your full credit card bills on time, stop using a credit card. If you cannot get rid of this bad habit, you may even have credit card recovery agent knocking at your door!
4] Not reading the detailed contracts of our investments and insurances: Reading the fine print is important, but we may be put off because they are often couched in jargon and/or printed in very small fonts. However, it is important to read up as much about the investment or insurance product you are buying.
Apart from the brochures, a lot of information is also available online. In case you need some clarity, you should ask your financial planner.
Let us take the case of a health insurance policy. It may come with certain exclusions or clauses like co-payment. For instance, if there is a co-payment clause of 20 per cent, and the hospital bill is Rs 4 lakh, then you will have to pay Rs 80,000 from your own pocket. Not being aware of such facts can land you in trouble.
5] Taking high-interest unsecured loans: If you do not have enough money to spare when planning a holiday, there are companies who would give you a holiday loan. Similarly, you will get loans to fulfil other financial requirements, too.
However, unlike a home loan, which is a secured loan, personal loans are unsecured, and come with a high interest rate of 10-24 per cent.
Nevertheless, they look very appealing and tempting as they are available for minimal paperwork and can be approved of in minutes. Having a big sum of money in your bank account definitely feels nice, but remember that you have to pay back the money at very high rate of interest, and defaulting on the payment would lead to more penalties and charges.
As a matter of fact, you should avoid such loans if they are not absolutely necessary. They should be your last resort in an emergency.