2 Understanding The Basic Terms

Suppose you got 1000rs as pocket money from your mom 

What will be the first thing you are going to do with it? 

Will you spend it buying your favourite toy? Would you save it to purchase your favourite book after one month, or will you ask your mom to keep it with her and give her double the next month? 

prioritise

To choose one among the above options, you must know the difference between your need and want. This understanding will help you to prioritise your money resources and know where to utilise them better. 

 Need means a necessity, something that is required and is essential for your living. For Example: buying fruits, vegetable clothing.

Want means mere wishes. They may not be essential but a desire of a person to get it. For Example: to buy a luxury car, buy an exotic fruit to taste. 

Need for one person can be a want for another person or vice versa.

Once you can identify your need and want you would be able to make better choices concerning money. 

 

                      Explaining the difference between need and want

Do you witness short of cash at the end of the month, and you might ask your mom to give you extra? 

 To understand and apply the golden equation of wealth (we will discuss in later chapters),  you need to weigh your needs and wants individually.  It is important to remember that need satisfaction has to be prioritised. Wants can be satisfied through the creation of additional wealth.

But to understand this, we must understand basic terms first.

  1. Expense- 

Any money spent to live. It can be money spent buying your school books, buying clothing, fruits, vegetables, or even visiting places.

Expenses can be necessary( unavoidable) and unnecessary ( avoidable) 

To control your expenses following steps can be followed: 

  • Keep track of necessary/unnecessary expenses
  • Record your daily expenses 
  • Total your monthly expenses and try to reduce them in the next month. 
  1. Income– 

The 1000 rupees given by your mom is your income. In short, The money earned or added in any form is called income. An individual can have one or multiple sources of income. Like you can get pocket money from your dad or mom. 

For Example:  in our previous examples, the mango seller sells mangoes in a day and might ride an auto during the latter half of the day. fulfilled

Different sources of income can be Salary income, Property income, Income from your business, Gains from stocks/ shares, or any other sources like winning the lottery, getting gifts, etc.

You can have multiple sources of income simultaneously. Whatever seeds of income you may have. It should be enough to cover your expenses and some money left to save for the future to lead a good quality of life.

  1. Saving- 

Suppose you spend just 600 rs out of your pocket money in a month. 

You have an extra 400 to be used next month. 

Saving is necessary to secure your future, financial independence and fulfil your needs and wants. If you wouldn’t have saved 400 rs from your pocket money, you might have to ask for money from your mom. 

In short, Savings = Incomes – Expenses When savings are negative, you might end up taking loans/ debts.

Lending money comes with high risk and liability to pay back. You might end up paying extra than you borrowed. The additional amount made with the sum you borrow is called interest. 

 

Options showing what you can do with the income you get 

Here is an activity for you. Calculate the amount of pocket money you got this month. Now subtract all the expenses you made from your pocket money. What do you get? Is the answer negative or positive?.

If it is positive, Voila, you have a surplus. Congratulations! With the extra money, you must pay off any debt or loan if you have. Otherwise, you can increase your monthly savings amount or invest in the future.

 If it is negative, Oops, you have a deficit. You need to increase your income or reduce your expenses by focusing on your needs rather than wants, to balance your budget. 

But how much money should one save?

You can save any amount you want to save. But having a reason to keep makes it measurable. 

For Example-  “I want to save to get my school books” this statement is very vague as you might not know how much you need to save. 

“I want to save for my art and craft book costing 600” this might be accurate as you know now you need to save 600 to get an art book. It is called Smart Saving.

 It’s more realistic and achievable. You might save 100 rupees for six months or 200 rupees for three months. 

There is also one smart way to multiply the saved amount- it’s called investing and getting more significant returns. We will discuss this in future chapters.

Points to be kept in mind when Saving :  

Make a plan of your saving and spending and save a portion of your income every month.

If having any debt, try to clear the high-interest debt before saving as they cost you .more 

As there are many options to save, choose the best option or simply keep in banks as FD, RD, etc. (refer to Banking)

Make sure that your savings are invested in diversified instruments (refer to topic Investments).  

Some portions should be in liquid assets so that you can withdraw money when needed. 

Do not put all your money in instruments that are very Risky / Unregulated, and you may lose all of it!!! Invest wisely.

 

 Steps involved in making smart savings 

Interest- 

The additional amount paid with the sum you borrow is called interest. It can be of two types: simple interest and compound interest. 

Simple interest is nothing but the amount paid on your principal amount ( original amount you borrow) for a fixed interest rate for a specific period. 

It can be calculated as :  principal(p) * Rate of interest(r) * Time(t) / 100

Compound interest means getting interest on the same amount repeatedly with an additional amount added within the interest or principal. You earn manifolds in compound interest. 

You get an additional amount on the principal amount in simple interest, but here you get the interest on the principal and the interest earned on that principal. 

 Explaining the compound interest

For Example, you have 100 rs for two years, and you gave it to your friend at 10%

Now in simple interest, you will earn interest of 100*2*10/100= 20rs, but in compound interest, you will get interest in year one: 100*1*10/100= 10 

Year 2: principal becomes 110 thus 110*1*10/100= 11 

The total interest you earned is 21, i.e., more than in “simple interest”. 

It is called the “Power of Compounding.”.

THINK ABOUT IT!

Can you guess which is more effective and yield more income at the end of 5 years? Simple interest or Compound Interest?