Tag Archives: liability
You plan a tower that will pierce the clouds? Lay first the foundation
Recap:Swayam was now king of the world. All the hours of studying in school, college had paid off, he had the job and he would spend money living life king size. But then he was pulled in different directions-taxes, savings, insurance, investments, stocks, mutual funds, . He realized he was educated but had no financial education and started on money awareness journey. He brushed up his school maths such as percentages, compound interest. He also learnt that It’s not what you earn that makes your financial position! Today he will learn about the four cornerstones of one’s financial position:Income, Expenses, Assets and Liabilities. Note these terms can be applied to companies and individuals but here we will focus on individual.
3. Assets : adds to one’s income now or in future strengthening one’s financial position ex: investments in gold/silver, deposits, stocks, mutual funds, art/antiques, land or house. Asset is something that generates money for you. If you have to work to generate money, then that is Income. If you do not have to work but keep getting money, then that source of Income is your Asset. Robert Kiyoski in Rich Dad, Poor Dad series defines Asset as one that puts money in your pocket. Assets are the things that we own that we could sell for money. Some common examples of assets are:
- A house or other real estate
- A car
- Household appliances
- Electronics like a TV or computer
- Our furniture
- Money in a bank account
- Clothing, shoes, etc
- Stocks, mutual funds, bonds, etc
4. Liabilities:is a form of obligation or responsibility. It represents an outstanding debt, products or services that have yet to be provided, or acknowledgment of responsibility and payment provided for damage caused through actions or negligence. Robert Kiyoski in Rich Dad, Poor Dad series defines Liability as one that takes money from your pocket. It weakens one’s financial position. Ex:
- An old vehicle that needs a lot of fuel and repairs,
- Personal loans,
- Credit cards,
- Education Loan
- Home loan or mortgage,
- Payment plans for purchased items purchases or commitments that we take and service for long period of time.
- After one year you would owe109 rupees (i.e. 100+100 x .09).
- At the end of the second year you would owe118.81 (i.e. 109+109 x .09).
- Good liabilities gives one leverage — e.g., home mortgage, student loans, business loans, etc.
- Bad liabilities put one at a disadvantage — e.g., consumer loans, credit cards debt, etc.
Liabilities can also be a significant source of expenses. Interest payments on loans and credit card debt can add up very quickly and really eat into our income over time. Then why do people own a liability? Because they think it will help them to build an asset such as home loan or mortgage. But good liabilities can turn bad. For example, a mortgage that is too large. As mentioned in earlier article,It’s not what you earn that makes your financial position MD is about to loose his job and he has home loan of 52 lakhs to pay along with regular expenses including children education , 1 lakh per month. He has some savings in Mutual Funds and insurance policy but..!
President of USA, Barrack Obama and his wife Michelle graduated with significant student loan debt. “We left school with a mountain of debt,” Mr. Obama said in 2008. “Michelle I know had at least $60,000. I had at least $60,000.( New York Times). Michelle Obama told women that when she and her husband left law school, the monthly payments on their school loan debt was more than their monthly mortgage payment, and that they only got out of that debt when Barack Obama wrote his two best selling books. To know more about click Obamas Financial Struggle
Net Worth: The amount by which assets exceed liabilities. This is one’s true wealth or net worth. It can be a useful tool to measure one’s financial progress from year to year.
The value in calculating Net Worth is to map out assets and liabilities to gain actionable financial insights. For example, if after mapping out one’s assets and liabilities, one realizes that one is up to Rs 20,000 in a savings account and has Rs 10,000 in credit card debt that one is paying 30% interest on, that can be an incredibly valuable insight to take action on.
To find out how much rich a person actually is one uses Net Worth. For example as per gulfnews.com
Mukesh Ambani remains the richest Indian on earth although his net worth has dropped by $4.4 billion (Dh16.16 billion) in the past year.
Savitri Jindal with net worth of $9.5 billion is ranked overall fifth in the list of 100 richest Indians and has become the richest woman of India.
richest.org website lists richest people in various categories – Sports, Hollywood. For example as per richest.org, Mark Zuckerberg’s, founder of Facebook, net worth is $17.5 billion (as on Sept 2011) and Aishwarya Rai Bachchan’s net worth is $35 million. Interested ones can read about Richest people of World and Rich people of India at bemoneyaware.com
What else makes one’s financial position? How can one have a strong financial position? Do you think house is an asset or a Liability?
“Swayam, salary or income is just one corner stone of one’s financial position”, said the voice. Swayam was shocked. “What do you mean? I thought earning well is what one’s money position all about?”. Voice said, “First of all what you get in hand is different from the figure quoted by companies in campus or offer letter. Your take home salary is much less than the Cost to Company or Net Salary.” Swayam replied, “Yes I was shocked on getting my first salary, it was much less than mentioned in offer letter. I had divided CTC by twelve to arrive at my take home salary. Only when I read about Salary, Net Salary, Gross Salary, Cost to Company: What is the difference did I realize my mistake. But a person who gets 20-25 lakh in salary, what problem can he have? ” Voice said, “Sorry to disappoint you. More the money, more the problems. Take the case of M.D”.
He bought a house in Navi Mumbai for about Rs. 80 Lakhs, – of this about Rs. 55 lakhs was funded by a loan from the State Bank of India. Over the last 4 years he had paid a lot of interest, but the principal outstanding was still Rs. 52 lakhs. He was also doing some SIPs which had seen an amount of Rs. 33 lakhs, but now in this market was worth Rs. 30 lakhs e does not have any debt investments except his LIC endowment policies – and all the policies are together worth Rs. 30 lakhs. So far fine. He just lost his job. What is at stake- Household expenses (including children’s school fees) -Rs. 100,000, EMI Rs. 52,000 Assuming he gets a job in 6 months, he will need Rs. 1.5L X 6 = 9 Lakhs”. To know more about this can read Subramoney.com:Risk strategy not Investment Strategy
“Unfortunate for MD but that is just one of case”, said Swayam. “OK tell me who is better off among following?”, asked voice.
- Shanker, 24, earns a monthly salary of Rs 20,000 from his job. His average monthly spending on livelihood and looking good is about Rs 18000. He currently has no investments and has an amount of Rs 10,000 overdue on his credit card.
- Ramu, 30-earns Rs 4000 a month as a bank clerk. He spends a maximum of Rs 2000 in a month. He has Rs 4800 in his savings account but has not made any significant investment yet. He has to pay an EMI of Rs 800 towards his home loan.
- Shikha, 26- is a housewife who gets Rs 10,000 from her husband every month towards household expenses. She make it a point to put Rs 1000 in her savings account as soon as she gets her ‘allowance’. She has managed to build a reserve of Rs 8,000 so far.
- David, 19-a third year commerce student has built an investment portfolio of Rs 5000 in mutual funds. He started investing a part of his allowance, cash prize and gifts on his 19th birthday, 6 months back.
Asked the voice, “Who is better off?” Swayam replied, “If income were the only indicator if your financial situation, then Asif’s situation can be considered the strongest. ” Voice interrupted.”But does he seems to be doing well with his money? Is his financial position rally strong? Can he take care of financial emergency like a job loss or drop in income? Thankfully unlike M.D he does not have kids and Home loan to worry about and also he has age on his side”
Nodding his head, Swayam said “Infact looking at the overall picture, Asif even with his fat paycheck, is in the worst financial situation at present. His expenses are almost as much as his income. And his credit card debt has got him into a financial mess. ” Voice answered,”Considering his meager monthly balance and high interest rate on credit card debt, Asif would need more than 6 months to payback the debt, if nothing else changes. And I would like point out to you that even in developed countries like US people are Financially fragile” Swayam was worried, “What does this mean? ” Voice replied, ” It means in an emergency situation they couldn’t come up with $2,000 unexpectedly in the next month, or would have to resort to desperate measures to come up with the money. A surprising number of middle class families – including 25 percent of those earning between $75,000 and $100,000 — are also fragile.
“I am speechless,” said Swayam. “But surely in India we would be better of ?” Voice answered, “Indian households are earning more as economic growth accelerates and putting aside savings, but they continue to remain financially at risk. They would not be able to cope on their current savings for more than a year. 54% Indians suffer from nothing-will-happen-to-me syndrome. These are some of the findings of a study done by the National Council of Applied Economic Research (NCAER) India and sponsored by Max New York Life, a private player in the life insurance space in the year 2007. For report How India earns, spends and saves: Unmasking the real India Click here (pdf)
With global crisis of 2008 behind us and US and Europe crisis facing us things have worsened.” Swayam asked ” Then What makes up one’s money or financial position?” Voice replied “It’s Income, Expenses, Assets and Liabilities“.
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