Financial literacy is limited by this extreme application orientation. Can we simplify personal finances? In a column length? Without complicating the principles of age, life cycle, preference and level of wealth? Hoping for the reader’s indulgence, I keep trying. Everyone associates wealth with assets. We can easily stay there and weave most of the principles around this idea. In our day-to-day life, our ability to spend on essentials and luxuries determines our sense of financial well-being and comfort. We need income to spend and our assets must contribute to this need and be useful in our daily life.
Many of us fail to make this connection about assets. I meet many NRI friends who have many properties in India. Neither they nor their children are likely to return or use these assets. The rental yield is low or even zero if they are occupied by relatives. They argue that they don’t need the income, but that they like the asset to stay. Much like the neem trees they grow inside their homes in America: never harvested or pruned, isolated from cold winters and simply a symbolic link to their past.
The choice of assets must obey the fundamental principle of value. Without being a store of value that can be drawn and used, an asset is wasted. Of all the assets, the human asset is precious. Not everyone has an inheritance. We use our skills, knowledge and attitude to generate income. As long as this income covers the expenses that we make on a regular basis, we are able to create more assets with the surplus.
We retire when human assets lose productivity and other assets built with savings can take their place.
Readers regularly ask if there is a formula for determining how much one needs for retirement. Estimating future expenses is not a science; only rules of thumb prevail. Many assume that keeping assets intact and making lifestyle compromises are the two tenets of retirement.
Instead, put your strengths together, I would say. Anything that you have accumulated from your savings during your working life should be useful in your retirement. It wasn’t that long ago that kids were the only assets. We now know that these assets will generate income for another household, not yours. Retirement is all about using your assets for yourself. Bequeath what remains, if at all.
Assets should not lose value, we argue. Fair point. In a world where rivers dry up and rains flood the homes of our cities, we don’t seem to have acquired intelligence of lasting value. Nothing we create exhibits the predictable discipline and resilience of natural wonders like the sun. Most assets do not have lasting value, not even humans. We have no choice but to manage this risk.
Therefore, we ensure human capital. We strive to protect our heritage should something happen to us even as we are building it. As for physical and financial assets, we demand risk-free, we run after gold and real estate; we try to hoard and hide; we stack and preserve. But all assets gain and lose value. Even the bank deposit loses value in the face of inflation.
Our intelligence as creators of wealth should guide us towards asset allocation and diversification: the strategic axes of wealth management. Not all assets lose all the time, and averaging them is a wise strategy. It protects our assets from unknown and unexpected risks and insulates us from our mistakes in choosing assets.
That’s all there is in personal finance: building up assets to generate income to spend and save; diversify your investments to support this process throughout your life.
We make several mistakes before we master this central idea in our financial life. We spend recklessly and don’t save; we spend beyond our means and incur credit card debt; we reorganize income and assets with loans; we choose assets with recklessness; we juggle assets with the hope that they will outperform; we lock our wealth into assets that we do not use; we deplete our assets in denial; we compromise on critical comfort by succumbing to fear of the future; and we live in the hope that all will be well.
Everything is not bad all the time. Much like a diversified portfolio, it averages. Columnists like me survive by repeating the same few ideas over and over again because there is always someone who resonates with it every time.
We have no choice but to learn to manage our personal property. The problem with teaching this skill is that no one cares about concepts or principles; people just want action points. What should I do now, they ask.
Personal Finance sustains an army of service providers who know these questions and strive to provide answers every time, with an eye to their own incentives and track records for asset building. One man’s problem is another man’s opportunity.
Someone like me who sits on a perch watching this drama is only amused and intrigued. My travel companion, who cannot hide his bag, will ask me for a stock name within 30 minutes of conversation. I can’t trust anyone with a few thousand; but can invest lakhs on the basis of hearsay. My aunt wears diamonds in her ears and looks at the price to change her mind on a saree she loves. Cannot indulge in simple pleasures; but retains expensive assets.
My friends who accuse me of being a mutual fund stooge can’t think past the stock bets they took and lost money on. Can’t stop to consider diversification even though they believed stocks were a growth asset. I’m not making any progress with the aged uncles who believe the whole world is here to get them and every financial institution is run by incompetent and dishonest people.
They base their case on saying that property is the best asset. They can’t see the brutality and fraud in a market they participate in, even if they blame another market they know so little about.
Thus, we continue to roll, unnecessarily complicating a simple exercise of building and using assets that everyone must master.
(The author is president, Center for Investment Education and Learning)