Friday, April 4, 2014

Monitoring Assets, Liabilities and Networth

One of the key aspects of financial success is financial discipline. Financial discipline is about doing things like investing, paying off debts on time, monitoring bank accounts to check for expected dividends, unexpected charged levied, etc. regularly.
Another aspect of financial success is to monitor some key numbers. These are Assets, Liabilities and Networth.

Assets are explained more over here.
Liabilities include loans of all types (home, auto, personal, credit card dues, loan from family and friends, festival advance, etc.) and any amount you owe anyone.

Networth is what you are actually worth after removing your liabilities from the assets.
Networth = Assets - Liabilities

Monitoring these key figures is important for these reasons:
1. If your finances are proper, you should see your Networth increase over time.
2. You know how much you are worth financially or how much is your family financially secure for future needs.
3. You can also monitor asset allocation and do the necessary diversification based on the needs and your risk profile.

Here is an example of how you can monitor asset allocation and monitor the key figures over time.
I. Sample Current asset portfolio:
NSCs          1,00,000
PPF                  5,00,000
Bonds          5,00,000
Fixed Deposits 4,00,000
MFs                  5,30,000
Stocks          1,20,000
Cash             2,50,000
Assets        24,00,000 
The above can be well representated as below in the pie chart:

II. Sample Liabilities:
Festival advance   10,000 
Vehicle Loan     3,00,000 
Liabilities     3,10,000 

Networth = Assets - Liabilities = 20,90,000

To monitor how these vary over time, it is important to take a snapshot of the above figures regularly (say every month end).

You can also look at the trend of your networth along with assets and liabilities:
This is all more of a one-time effort to put the tables and graphs. Then, it is easy tracking your finances and see your wealth grow (hopefully) over time.

Wednesday, April 2, 2014

Free float

Float has many meanings depending on the context. Beverages, Finance - in terms of shares available for trading; moving/changing amounts; and also Savings and Current account of banks.

In the perspective of savings accounts of individuals, the float what I am referring to is the liquid cash lying in the savings account which is useful for taking care of emergencies, exigencies and sundry expenses. We should not keep an excess float as this earns us a lower interest rather than investments. There are a few particular situations when the float or the savings balance should be high:
1. You are expecting high expenditure soon
2. Lack of investment opportunities vis-a vis risks in those investments
3. Temporary cash while transitioning across asset classes. i.e., selling one asset to buy another or to settle some liability

As an individual, we should maintain this cash in more than one bank account for convenience and availability and risk diversification. Lets understand this aspect a little better with an example:
If you have two bank accounts with Rs.30,000 each and say, you suddenly need Rs.10,000 for an emergency. You can draw from whichever ATM is nearer (although most ATMs are now inter-operable across banks). But, say the ATM is out of order that day or out of cash, then the choice of the other ATM is your answer. On another day, if you needed, say, Rs.40,000 and the daily limit of withdrawal is Rs.20,000 then this diversification will help you draw the money when in need. If the entire money was in one bank account, this would not be possible.

There is a tradeoff between liquidity (keeping a lot of cash in the savings account) and the rate of return on investment. The more the cash in savings account the lesser the money is earning interest compared to investments.
One can never really say how much money would be required in an emergency. With medical expenses very high, it is difficult to say how much is too much. A better way to manage this emergency liquidity is to make sure your close family members (spouse, siblings and parents) also maintain some emergency money in their accounts. That way in an emergency, the pooled money would be more than enough to tide over the emergency. This two way mechanism of helping each other out in case of an emergency can help all the people from keeping excess money in savings accounts. The family members are more like your second line of source of money in case of an emergency. To truly implement this in word and spirit, each of the parties should have already enabled third party transactions and should have added the other persons' accounts to their third party transfers. The enabling of a new third party can vary from a minute to 24/48 hours depending on the banks' policies.
If this is implemented, money can be transferred from one account to another by logging in and transffering funds in a few minutes.
Remember that another very useful source of money in emergencies is a credit card.