I don't have a head for numbers

“Wow, you must be really good in math to be in finance. I don’t have a head for numbers. I leave all that to my husband/father” is a common rejoinder I get from women when I tell them what I do. It’s true that finance has a lot of numbers, but not necessarily a lot of complicated math, as people think. Especially in personal finance. In fact, the only math you need for personal finance you probably help your kids with – basic addition/subtraction, multiplication/division and percent/fraction.

I will walk through the numbers, but perhaps a better place to start is what the numbers achieve. Once you understand the objective, the math and numbers will make more sense.

Personal finance concepts

‘Personal finance’ basically covers anything related to money in your daily life. The three main concepts in personal finance that you need to know about are -

• income/expenses,
• assets/liabilities, and
• insurance/investments.

You will also need a basic understanding of some things that happen in the society or economy you live in, such as taxes, inflation and demand/supply imbalances for things or people, but we will cover that another time.

Income and expenses

Basically money in, money out.

Most people understand this. As soon as you become an adult, you start earning an income. Obviously you want to earn as much as you can, so you go to a good college to learn a skill and get a qualification that’s in good demand. That’s money in, or income. You spend some of the income to buy things today – that’s money out, or expenses.

Hopefully you save some of the money for the future. A good rule of thumb for saving is 30% or one-thirds (see how percent and fractions are related?).

It’s always good for the income number to be higher than the expenses one. It should be obvious that you can only spend what you earn, although society does allow you to borrow so you can earn even more - on the promise that you will return the loan with interest. It’s never a good idea for you to spend more than you earn for anything else.

Assets and liabilities

These are things that will cause money in or money out in the future, so they are future income and expenses. 

Remember you saved part of your income. Unless you are from the era that used to hide cash under the mattress, you will likely leave it in a bank savings account or convert it to fixed term deposit. The ‘saving’ has been converted into an ‘asset’ because it now earns you an income, in this case called interest.

Or you could buy gold jewellery, a property, a business or a financial investment like shares or mutual funds. All these go into the assets column of your personal balance sheet. You can convert these assets to pay for expenses in the future.

Now if you had decided to borrow, you will have some debts or liabilities. Hopefully, you have ‘good debt’ i.e. the loans actually help you increase your income or your assets. Examples are loans to fund higher education, or to buy a tangible asset like a property, or business, or financial assets.

Some people borrow to spend today, such as to take vacations or buy ‘things’ such as cars, electronics – these are bad debt. These are usually on credit cards or through personal loans (those that don’t have a collateral), so have a high interest rate of 18-25% per annum, which can compound out of control very quickly. If you have these, you should pay them off immediately.

Try making a list of all the assets and liabilities you have.

Investments vs Insurance

When you put an asset to ‘productive’ use, it’s called an investment. We could argue whether a bank deposit or fixed term deposit qualifies as productive use – so we call them assets but not quite investments.

Similarly, buying real estate is not quite productive – we will discuss this in future. The most productive is to put it into a business, which employs people. It could be your own or someone else’s. When investing into other people’s businesses, you can lend it at a pre-determined interest rate, or you can take an equity stake in their business with unlimited upside and downside. Depending on the risk of getting your money back, you get a commensurate return on your investment.

So far you’ve earned an income, spent some, and saved the rest. You then put some of the savings in the bank, creating assets, and invested some, making investments. If all goes to plan, you will earn enough money to pay for all your goals such as buying a house, children’s education, weddings and comfortable retirement.

But life doesn’t always go according to plan. Accidents happen. Imagine you have an accident – both you and your car get badly damaged. You can’t work for a while, and therefore not earn an income. Most people have car insurance to cover the damage but don’t insure their own income. How would you pay for your fixed expenses of rent, groceries, school fees, etc while you are laid up in bed? Wouldn’t it be nice if your family members all contributed small amounts to help you out?

Now imagine instead of just your family, it’s all of society that contributes. That’s what insurance is. A lot of people contribute small amounts into a pool that pays out a big amount to someone who has a misfortune.

Insurance is available for pretty much all types of assets – your life, your ability to earn income, medical expenses, property, home contents, car etc. Indeed, insurance is available for large expenses too like travel.

Just remember, insurance kicks in when bad things happen. That’s why when you make back-up plans, they call it an ‘insurance policy’. On the other hand, investments give you returns because you are putting the money to productive use in the economy. Don’t mix the two!

The only numbers you really need to know

Once you’ve understood these concepts, the only numbers you really need to know are -

How much are you saving? Simply subtract monthly expenses from monthly income. Make sure this is positive (minimum of 20% of income and ideally closer to 30%) and growing every year.

What’s your net worth? Add up all your assets and liabilities separately. Subtract your total liabilities from your total assets. Make sure this is also positive and growing every year.

How much are your investments earning? You should have a mix of investments with different risk/return profiles. Usually, the higher the risk, the higher the return. Given the expected growth rate of the Indian economy, it’s reasonable to expect the Indian equities market will return 12-15% per annum – on average. However, the returns bounce around a lot - I will explain all of this in a separate blog.

Is my family taken care of should something bad happen to me? Everything will fall apart if you don’t have an ability to earn an income. So the first thing to insure is your own health. Then you need to figure how to replace your income if you fall sick for an extended period. If you have dependants who rely on your income, you also need to have life and disability insurance. If you have built substantial assets, you need to insure those too. Add all these up and make sure you have adequate insurance.

And the end result

Are you likely to meet your goals? If you keep doing what you are doing, have you accumulated enough assets that are earning well enough to help you achieve your goals? A financial adviser will help you do this calculation. It’s not really hard to do in a spreadsheet, but it does require some projections about how much your goals will cost in future and how much your investments will return. (The real skill is in the projections, not the calculations).

That’s it! These are all the concepts and numbers you need to know to manage your money. Hopefully, by putting the numbers in context, you can see you don’t have to have a head for numbers any more than what you learnt in school. In the next post, I will walk you through the calculations too.

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