Financial Basics
Financial Basics
Today’s financial world is highly complex when compared with that of a generation ago. Forty years ago, a simple understanding of how to maintain a checking and savings account at local banks and savings institutions may have been sufficient for financial transactions. Now, consumers, must be able to differentiate between a wide range of financial products and services, and providers of those products and services. Previous, the less-indebted generation may not have needed a comprehensive understanding of such aspects of credit as—the impact of compound interest, and the implications of mismanaging credit accounts, etc.
There is a need to increase consumer awareness about the necessity of financial literacy and how they can access it. Financial literacy is not just for investors. It is just as important, if not more so, for the average family trying to balance its budget and save for their children’s education and the parents’ retirement.
The need for financial literacy of consumers at various stages in their lives, and how financial literacy programmes can be designed to best address these needs have to be understood more. Financial literacy involves imparting knowledge about the risk and return of financial products to the users and providers of these products. It is this knowledge that helps in containing risks and maintaining stability in the financial system. Financial basics explains about Bank accounts, Online and Mobile Banking, Debit Cards, Credit Cards, Cheque, PAN Card, ATM Awareness, Loans, Investments and Insurance and Taxes.
No frills Account
The no-frills account has been introduced to bring a large section of under-privileged people into the banking net as well as and reduce credit rationing for this section of people.
The Reserve Bank of India has urged the banking community to introduce the no-frills account to bring a large section of under-privileged people into the banking net. The idea has been propelled by the realisation that even with 70,000 bank branches in the country, a large section of the population continues to remain credit-starved.
The no-frills bank accounts will, therefore, be an innovative instrument to introduce the concept of banking to the under-privileged and reduce credit rationing for this section of people. As the individual bank would have the privilege to design these no-frills accounts, the basic characteristic would involve zero or a very low balance with limited transaction facilities.
Despite concerns about the servicing costs, many financial economists believe that it could be an effective instrument to combat credit rationing and provide the much-needed credit to a large section of the under-privileged population in the country.
Example: SBI No-frills Account Details
This account comes with very low minimum balances as well as low/ nil charges, to cater to the needs of individuals from the vast sections of population who are, otherwise, not fulfilling certain conditions of our existing Savings Bank account requirements. Details are as under:
- Eligibility: Individuals of 18 years and above earning a gross income of Rs 5000/- p.m or less.
- Mode of operation: Single/ joint
- Initial deposit amount: Rs 50/- to open the account
- Minimum balance: NIL
- Maximum balance/ amount: Rs 10,000/-, being the total value of business connection of the account holder, including other deposit accounts.
- Rate of interest: As applicable to Savings Bank account, i.e. 3.5% p.a.
- Cheque facility: Available.
- ATM-cum-debit card: Will be issued free of charge.
- Internet Banking facility: Not available
- Number of accounts: Ordinarily, a customer will not be allowed to open more than one basic banking ‘no-frills’ account.
- Passbook: Will be issued, updation will be permitted between the 11th and 20th of each month.
- Charges for availing services other than those covered here: The schedule of charges for availing services other than those covered in this product are being displayed in the branch premises/ notice board.
- Nomination facility: Available
- Product available at: All branches, except specialised branches.
Loans
When you apply for loan, the banks want to see how financially sound you are. Some of the main considerations on which loan eligibility is decided include your repayment capacity, age, income, source of income, credit score, educational qualification and the relevant documents that you submit in support of your loan application.
Many types of loans are available: They are in the form of home loan, home improvement loan, car loan, loan for two wheelers, educational loan, wedding loan, business loan, loan against security, personal loan and NRI loan. Interest can be calculated on a daily, monthly, quarterly or annual basis. The outstanding principal loan at the end of each of these terms is taken into account for calculating the interest rate.
Loans can be classified as secured or unsecured. Further, they can be based on fixed rate of interest or floating rate of interest. In case of secured loans, you are required to pledge your home or any other valuable security. In case of unsecured loans, there is no such requirement. Unsecured loans are for your short-term monetary requirements whereas secured loans can be taken for longer periods. The amount of loan that is available under unsecured category is limited, whereas, in case of secured loans, the loan amount can reach very high proportions depending upon the value of your home. You can take loans against securities or any other valuable asset that the bank is willing to accept.
Interest Rate
The interest rate depends on loan agreement. Interest rate can be Fixed or Floating/Variable depending upon which option you availed at the time of taking a loan.
- Simple interest is calculated only on the principal amount, or on that portion of the principal amount which remains unpaid.
- Compound interest is very similar to simple interest; however, with time, the difference becomes considerably larger. This difference is because unpaid interest is added to the balance due. In other words, the borrower is charged interest on previous interest. Assuming that no part of the principal or subsequent interest has been paid, the debt is calculated by the following formulas:
- Loans with Fixed Rate of Interest - Once agreed upon, the interest rate remains same throughout the period of the loan.
- Loans with Floating/Variable rate of interest - Some loans are based on floating interest rates. In such cases, the interest rate payable is linked to the market rate of interest like the bank’s prime lending rate. Any change in the official interest rate by the RBI may affect the rate applicable on your loan.
Some banks have provision for internally rating the borrower on different parameters. A rating or score is assigned to each borrower, and accordingly, the terms and conditions are decided by the bank. Higher credit score means higher loan prospects.
Collateral Security
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan. The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation. If a borrower does default on a loan (due to insolvency or other event), that borrower forfeits (gives up) the property pledged as collateral - and the lender then becomes the owner of the collateral. In a typical mortgage loan transaction, for instance, the real estate being acquired with the help of the loan serves as collateral. Should the buyer fail to pay the loan under the mortgage loan agreement, the ownership of the real estate is transferred to the bank. The bank uses a legal process called foreclosure to obtain real estate from a borrower who defaults on a mortgage loan obligation.
Equated Monthly Instalments (EMI)
EMI stands for “Equated Monthly Instalments”. When you take a loan, the amount to be repaid every month is calculated in such a way that all your outstanding dues are cleared at the end of the loan period. This monthly payment that includes interest as well as the principal amount is called an EMI. Loan repayment is generally made with the help of Post Dated Cheques or through Electronic Clearance System (ECS) that is directly linked to your bank account. In case of Electronic Clearance System, repayment is deducted automatically from your bank account on an agreed date. Loans are available in the Indian market for a period starting from 6 months to 25 years. The exact duration depends upon which loan plan you have chosen, and it generally varies from bank to bank.
Investments
In addition to a savings account, investing in stocks and mutual funds can help you save for the future. While stocks and mutual funds can potentially earn higher rates of return than regular savings accounts, they can also decrease in value depending on the prevalent market conditions. It is always wise to do your homework and make sure you understand the risks before investing.
Types of Investments
Stocks
A stock represents partial ownership of a corporation. Stockholders own a share of the company expressed as a percentage of the company and are entitled to a share of the profits. Stockholders even get to vote on company decisions. The company profits may be divided among shareholders and are called dividends. Dividends are usually paid to stockholders quarterly. Stocks are traded on the open market, which means they can earn money when the value of the stock, the market value, increases. They also can lose money when the value decreases. This can be an advantage when the market value is up, but it can be a disadvantage when the market value goes down. You can see why “playing the stock market” can be tricky, so it’s a good idea to get help from a brokerage firm or an advisor with experience.
Mutual Funds
A mutual fund is a portfolio of investments that is managed by a professional investment advisor. It is made up of stocks, bonds and other investments, and is owned “mutually” by many investors. When you buy shares, the fund uses the money to purchase stocks, bonds and other investments. The profits are returned to the shareholders monthly, quarterly or semi-annually in the form of dividends. The advantage of mutual funds over individual stocks is that small investors can benefit from the advice of a professional account manager who distributes the investments among different companies or securities in an effort to limit losses should a certain market or industry not do as well as expected. But keep in mind that this has some of the same risks as buying stocks. Even though your investment is now “diversified” and someone is watching it for you, it still can decrease in value. Investing in stocks and mutual funds is a great way to help you save for the future, but it can be risky. Be sure that you understand how stocks and mutual funds work before you invest.
What is Financial Literacy? Why is it important?
Introduction
Financial literacy is the ability to manage one’s money. The goal of financial literacy is to help in understanding financial concepts that will help them to manage their money better. It is a life skill that one must grasp for good financial wellbeing. Financial literacy includes budgeting, investing, insurance, and loans and interest. In this article, we have covered the importance of financial literacy and how can one improve their financial literacy skills.
What is finance in simple words?
Finance is the management of money. It includes activities like savings, investing, borrowing, lending, budgeting, and forecasting. Finance has three main categories, namely personal finance, corporate finance, and public finance.
Personal finance is specific to an individual and includes banking, purchase of financial products like credit cards, loans, insurance etc. Corporate finance includes activities related to running a business. Like the issue of stocks and bonds and also includes activities related to financing a project. Public finance includes budgeting, taxing, spending by the government for the welfare of the public. The fiscal policies that the government drafts also comes under public finance.
What is financial literacy?
Financial literacy is the ability to understand and effectively use financial skills. These financial skills are as simple as budgeting, investing, credit management, and financial management. In other words, financial literacy is the ability to manage money. A strong foundation of these financial skills will help in achieving various life goals like retirement, education, and even going on a vacation.
Financial literacy includes many skills. However, the most popular ones are budgeting, managing expenses, paying off debt and understanding the risk return trade off in investment products. Acquiring these skills would require one to understand the basic financial concepts like time value of money, compound interest, annualized return and opportunity cost.
With an abundance of credit products available in the market like credit card debt, overdraft facility on debit cards, and EMI, financial literacy becomes important. Understanding debt and having basic financial knowledge will help individuals to use these products responsibly.
Financial literacy often teaches individuals how to make major financial decisions. Moreover, it increases financial discipline and financial capability. This will lead to major lifestyle changes like saving and investing regularly, managing debts effectively and fulfilling life goals efficiently. Additionally, financial literacy will ensure one’s financial wellbeing and also protect individuals from financial frauds.
Lacking the knowledge of these skills leads to financial illiteracy. Financial illiteracy leads to budget mismatch, higher expenses than income, accumulation of debts, poor credit score, being victims to financial frauds, and other negative consequences.
Why is financial literacy important for you?
Financial literacy is important because it equips one with the knowledge and skill to manage money effectively. Without financial literacy, the actions and decisions one make or do not make with respect to savings and investments would lack a strong foundation. Financial literacy helps in understanding financial concepts better and enables one to manage their finances efficiently. Furthermore, it helps in effective money management, making financial decisions, and achieving financial stability. Moreover, financial literacy provides in depth knowledge of financial education and various strategies that are indispensable for financial growth and success. Also, it enables one to be debt free by adopting the best debt strategies.
One can understand the importance of financial literacy by understanding the four components of financial literacy better. They are:
Budgeting
Budgeting is an essential life skill that helps in acquiring financial knowledge for planning and managing money. It is one of the most important components of financial literacy. It is necessary to keep a tab on one’s spending habits. Optimal money management will help in creating an actionable financial plan. The actionable plan will help in tracking the expenses, segregating the unnecessary ones and help in spending money wisely. This way, one can save more. The thumb rule for budgeting is that income has to be greater than the expenses. The difference between the two (income and expenses) is what helps in stashing up as savings.
Budgeting helps in planning for short, medium and long term expenses. It enables individuals to save accordingly. Hence, one doesn’t require to compromise on any of their goals. Therefore, budgeting is vital for financial security and independence.
Debt
Debt is nothing but one’s borrowing. One is spending money that isn’t theirs. For example, if an individual borrows money from the bank or uses a credit card or takes a short term loan. All these become part of the debt.
Mostly, debt is perceived in a negative aspect. Which makes understanding debt very important. However, not everyone can buy a house or car or pay tuition fees with cash. In such scenarios borrowing or taking a loan is the only way out. But the most important thing is to differentiate between good debt and bad debt. Also, one should always aim to avoid bad debt as much as possible. This is the basics of debt management.
Good debt is borrowing money for things that are necessary for making a living. For example, buying a home or paying education expenses. On the other hand, bad debt is borrowing money for unnecessary expenses. For example, using a credit card to buy expensive clothes or electronic gadgets, etc.
Therefore, being able to differentiate between necessary and unnecessary expenses will help an individual from not drowning in heavy debts.
Saving
Saving ensures financial wellness, a secure present and an uncompromised future. One can build wealth in the long term through proper financial planning. Keeping a tab on one’s spending habits will help in saving money. Therefore, through savings, one can easily achieve the following:
Achieve important financial goals. For example, full payment of a home loan, kid’s education, and retirement savings.
Create an emergency fund. An emergency fund acts as a cushion during unexpected life events. The fund should have at least six months worth one’s income.
Inculcate financial discipline. Through saving money regularly, one can achieve financial discipline and excel in their life.
Investing
Instead of holding the money idle in a bank account, one can divert it to financial instruments. Investing is all about generating and growing wealth to enjoy a secure and happy future. It is all about putting money in an avenue that will help in generating significant returns over time. Investments will help in generating additional monthly income and significant returns. One can also achieve their financial goals at the same time allocate funds towards retirement saving. Some of the widely used investment options are equities, debt instruments, mutual funds, real estate, and gold.
Therefore, becoming financially literate will help in:
- Building wealth
- Protecting oneself in case of emergencies
- Achieving goals
- Securing one’s family future
- Retirement planning
- Lead a stress free life
How to improve your financial literacy skills?
Developing financial literacy skills is essential. It helps in improving personal finance management. Personal finance is a process which involves learning, practising and applying a variety of financial skills. It ranges from budgeting, managing, paying off debt, understanding credit and various investment products. The following will help in improving financial literacy skills:
Create a budget: One should start tracking their income and expenses on a monthly basis. This will help in segregating necessary and unnecessary expenses.
The budgeting process should include:
- Income (payslips, investments etc.)
- Fixed expenses (bills, rent, loan payments, etc.)
- Other expenses (shopping, travel, etc.)
- Savings
Manage bills: One has to ensure they are paying bills promptly. Choose auto debit options for recurring bills from the bank account. Set up payment reminders to stay on top of monthly bill payments. Paying bills should not be postponed or neglected. Hence one needs to make it as a priority in their budgeting.
Maintain a good credit score: Having a good credit score will help in getting the best interest rates on credit cards and loans. Therefore, aim to maintain a good score that will help in the case of borrowings.
Manage debt: Manage debt by reducing spending and increasing repayments. Have a debt reduction plan that will help in reducing the liability. For example, paying off loans with high interest rates first.
Start saving and investing: Savings is not difficult when it is done systematically. After proper budgeting, all the one has to do is identify financial goals and put their financial resources to optimal use. One can divert their financial resources (savings) towards investing. Investing in a goal will help individuals achieve them easily. Small and regular savings will help in realizing life goals without much stress. Systematic investment plans will enable individuals to save a fixed amount regularly every month. Also, the key to generating significant returns is to have a long term investment horizon. Therefore, one should have a good strategy for identifying financial goals, segregating them as short, medium and long term goals and investing. Also, it is important to be patient with investments and not get panicked with market volatility. Furthermore, one can consult a financial advisor for planning their investments.
Conclusion
Financial literacy is a major life skill one needs to have as it increases your financial capability. Planning finances, managing budgets and savings should be taught right from the school days. However, it’s never too late to learn about it. One can improve financial literacy by understanding the components of it. One can always begin their investment journey even after they turn 50. But starting early has its own benefits.
Let Scripbox help you in managing your money optimally. Scripbox is a financial solution provider who will customize a plan for you to convert your savings into investment. All one has to do is to set their goals and plan their finances. Make a budget and save money. We will help to convert the savings into investments and guide in achieving life goals. Scripbox’s readymade plans are available where one can choose any life goal. Alternatively, we customize plans based on individuals’ goals and finances.
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