Do you think you are well aware of the basics to create the kind of wealth you dream of? Most often the answer cuts for a sorry figure, and you just might be surprised how specific simple financial ideas and concepts might change your life for better, if and only if, you pay close attention.
Here are a few things to make you sit up and think before you plan your financial future.
Impact Of Taxes and Inflation on Earnings
You might wonder why we began with taxes and inflation instead of something like savings and investment. The reason is being that to save and invest successfully. You need to know about these two fundamentals and how they impact the outcome of your savings and investments in almost any form.
You might have saved a few your earnings at home in cash or set it aside in the form of a safety deposit or fixed deposit to be used later and to earn interest on your savings as well. However, any savings you decide to keep in your hand or a piggy bank are losing in terms of purchasing power due to inflation.
Similarly, your fixed deposit is earning you lesser than you think if you decide to factor in the impact of inflation on the interest earned annually. If you take care of inflation while planning your savings, you might save enough to help your kids buy their first car and save them the trouble of looking for small car loans.
On average, inflation grows at a rate of around 3 per cent annually. It needs to be taken into account when calculating how much you earned in terms of interest or profits on your savings or investments. Taxes are another major factor that impacts the outcome of your investments.
You need to know about all tax deductions to be made when choosing to withdraw your savings or investment. Usually, long-term investments attract higher tax benefits and tend to earn you more in that respect. For savings, if you put aside your money for a fixed term, it attracts fewer taxes in the longer term.
What Is Your Net Worth?
You might have heard about how much the net worth of some big companies increased on an annual basis. So what is this net worth and does have any relevance to you, personally? The answer is yes.
If you take all your assets, earnings, savings and investments put together and then deduct any liabilities and dues from it, what you arrive at is essentially your net worth. In simple words, how much are you worth in financial terms after paying off all your dues and taking into account your total wealth and assets.
You need not despair if your net worth does not account for much if it is at least on the positive side. It only means you have managed well enough so far to avoid falling into the trap of bad debts and perhaps maintain a good credit score as well. It indicates your finances are in somewhat a good shape and there is little chance of you looking for lending options like guaranteed car loans for bad credit and then hoping to find some way to hold things together.
If your net worth is near zero, it is still not that bad, and you need to work on your strategies for wealth creation if there are any as yet. If your net worth is in minus, then it is, of course, a cause for genuine concern and shows that you need to get your act together. Bad debts and poor credit score often make an appearance in such cases and need to be handled deftly to avoid falling into the trap of poor debt management worsening your financial situation.
Interest and the Effect of Compounding
You might think it’s a bit childish or almost embarrassing to talk about simple interest and compound interest or learn the basics as a grown-up. Well, you could not be more wrong. Most of the adult population chooses to turn a blind eye when it comes to the compounding of interest and puts their hard-earned money in any financial instruments or saving schemes based on how much interest they are paying. What they miss out on is whether they will earn simple interest or compound interest on your savings or investments.
In simple words, simple interest accrues interest ONLY on the principal amount for a specified period. On the other hand, compound interest works by allowing the investor to earn interest on principal AS WELL AS on the interest accrued annually. This slight difference in earning interest on the principal amount alone and earning interest on interest can significantly impact your level of wealth creation in the long term.
Compounding of interest needs to be kept in mind both while borrowing and lending or investing money. You need to borrow from a place where you get to pay simple interest, and you need to lend or invest where you get to earn compound interest as far as possible.
You need to take stock of some fundamentals to plan your finances the right way. Here is an outline to get you started and looks a little deeper, read the fine print to understand things better and not be deceived by appearances when it comes to wealth creation.