4 mistakes leading to the personal finance disaster

It is important to maintain the well-being of your finances just like your health. Sometimes in order to save more or in the expectation of earning more returns we 

​accidentally commit some mistakes which lead to the personal finance disaster.
I will discuss these mistakes and the ways to avoid them by understanding their consequences through the method of quantification. 

(1) Not having the adequate health insurance or taking it at the later stage

In today's time, the cost of the health is very high and it is very difficult for the normal person to afford the cost of medical expenses and the treatment from its own pocket. Moreover, most of the people living in the metropolitan cities are leading sedentary lifestyles which are one of the major causes of the many diseases. I will explain with the help of an example, say someone is 25 years of age and the medical insurance premium at this age is Rs. 7,500 ($110) per year for the insured amount is Rs. 10,00,000 ($15,000). We will compare the cumulative cost of the insurance which John will pay till the time of his retirement and the insured amount provided to him by the company. For that I am making following assumptions:

• Present age: 25 years
• Present Premium amount: Rs. 7,500 ($110)
• Insured amount: Rs. 10,00,000 ($15,000)
• Rate of increase in the premium amount: 6% per year
• Retirement age: 60 years
• John will never get hospitalized and pay only premium till his retirement

Incorporating these facts & assumptions into the chart & the table, we get:

​You can see that John end up paying a cumulative premium of Rs. 8,93,406 (approx. $ 13,000) against the insured amount of Rs. 10,00,000 (approx. $ 15,000). Moreover, John has not claimed anything from the company in these 35 years, therefore he is entitled for the No claim Bonus (NCB) (No Claim Bonus is the benefit, in the form of reduced premium amount or the increased insured amount, provided by the insurance company to the insured).
You can see that I have not added the benefit of NCB neither in the table nor in the chart. Isn't a better deal?
Yes,
John's insured amount > The cumulative premium paid.
There are certain life threatening diseases which are not covered for first 3 years by the companies but after this period all these diseases are covered. Therefore, it is advisable to take the life insurance early, so that one can actually avail the benefit of health insurance when required.
Take health insurance which covers your need.

(3) Not having the life insurance cover

Remember, the Health Insurance and the Life Insurance are the two sides of the same coin or are independent events. Health Insurance covers health for life and Life Insurance takes care of the things after life (Death). Can anyone imagine a situation of the family after after her/his death?
A mere thought of this gives a whole body shivers. When you are the bread earner for your family, then it becomes important to provide financial support to the family even after you. Therefore, it is important to take the right amount of the Life Insurance for your family in order to maintain their life style after you.
So, how do we calculate the right insurance amount for the family?
Well, I think the present income and age can help me in getting the answer. Let's take the example of John:

• Age: 25 years
• His present annual salary is Rs. 3,00,000 (Approx. $ 4,400)

I need to assume the following things to get the answer:

• Expected increase in his annual income: 7% per year
• Retirement age: 60 years

Let us incorporate the above facts and the assumptions into the table and the chart:

The annual income is increasing at the rate of 7% till John's retirement. Now, I need to discount the future earnings of John into present so that I can determine the present value. I am assuming the discount rate as 5% (saving bank interest rate) and I will discount the future earning by 5%. 
How to do this?
Simple, at the end of his 25th year, the John's annual income will be Rs. 3,00,000. In order to get the present value of Rs. 3,00,000, I will discount this value by 5%, like Rs. 3,00,000/(1+5%) = Rs. 2,85,714. Similarly, the present value of his earnings at the end of the 26th year is 3,21,000/(1+5%)2 = Rs. 2,91,156. When I add the present values of all his earnings every year, I will get the total present value of John's income in 36 years and this value will become base of my Life insurance. If I add all the present values of his future income, the total present values comes out to be:
Rs.(2,85,714 +2,91,156 + ..........+ 5,53,017) = Rs. 1,45,86,425 (Approx. $ 2,15,000)
Now, I can say that John should at least get a Life Insurance cover of Rs. 1,45,86,425 (Approx. $ 2,15,000) in order to maintain the lifestyle of his family.

(3) Inappropriate use of the credit card

Your credit card can prove useful when you use it in the emergency but the careless and the inappropriate use of the credit card can prove to be the one of the major financial mistakes and paying its interest amount can be quite painful. The credit card companies charge interest on the daily basis. For example, the annual percentage rate of a credit card company is 30%, 
you can easily calculate the daily interest by dividing this value by 365 days, 30%/365 = 0.082% on the daily basis. Let me assume that John owe Rs. 1,00,000 (Approx. $1,500) to the credit card company and carried this amount for 30 days. The interest on amount will be calculated as:

• Rs. 1,00,000 * 0.082% * 30 days = Rs. 2466 (Approx. $36)

The interest of Rs. 2466 (Approx. $36) is due on John. If John do not pay the due interest in time then he is going bear the penalty charges. In addition, the annual charges and the other miscellaneous charges prove to be a very expensive affair which can dis-balance the financial budget and can prove to be a financial mistake. You should keep in mind the following things before using the credit card:

• Pay your balance in time
• Use the credit card only in the emergency otherwise use debit card
• Never over-buy from your credit card 

If I am earning an annual return of 45% on my investments then I can think of paying interest at the rate 30% per year, otherwise it will be a foolish decision on my part to make unnecessary use of credit card.

(4) Investing in the stock market using exposure

Investing in the stock market is a good investment option, but it takes a negative direction when in the expectation of higher and quick returns, the investor starts using the limit of the exposure. The limit or the exposure is the credit limit which the stock trading company provides to its investors to invest in the stock market. The excessive use of this feature can prove very lethal as â€‹It can even wash off your money in no time.
Let us understand it with the help of an example, John is having Rs. 1,00,000 (Approx. $1,500)  of his own and he is interested in investing this amount in the stock market. In the expectation of good returns, he takes 4 times credit that is Rs. 4,00,000 from the stock trading company and invest a total of Rs. 5,00,000 (Rs. 1,00,000 of his own + Rs. 4,00,000 credit) into the stock market. Now I will consider the two cases:

• Case I: John invested Rs. 5,00,000 and he get a return of 5% (Rs. 25,000) on the invested amount. As his only investment is Rs. 1,00,000, the return on his investment is (25,000/1,00,000) *100 = 25% which is a very good return.

• Case II: But +25% on  the investment is only the one aspect of the scenario, there are chances that his investment may nosedive, giving him a negative return (-5%) on the total investment, then the return on his investment would be -25%, a loss of Rs. 25,000. It means that he is left with only Rs. 75,000, the remaining Rs. 25,000 is washed off.

As the company has lend you Rs. 4,00,000, it charges interest @ 24% per year, further increases your overall loss. Now, you can see that investing in the stock market using credit can be very dangerous for your financial health.
Always invest in the stock market with your own money, any credit amount invested in the stock market can lead to the personal finance disaster.

Conclusion

​The financial management is a regular exercise which requires your time, patience and common sense. A disciplined approach towards this helps you in managing your finances quite effectively.