Personal Finance

New year, old money. How to handle your finances in 2021?

Toxic Financial Habits to Leave Behind in 2020

Yet another year has come to an end, and it is finally time to confront some of our toxic financial habits. Many of us often do not consider how frequently overspending on accessories, clothes, or other miscellaneous expenses can affect our finances. We often don’t plan our budgets and spend spontaneously. 

Let 2020 finally be the year that makes us take a critical look at our financial habits. Here are some toxic financial habits that need to be left behind going into 2021:

  1. Not Understanding Opportunity Cost

The concept of opportunity cost can prove to be quite useful in decision making. By definition, opportunity cost refers to the profit potential of other alternatives that are lost when you choose one alternative. For example, you could choose to spend a large chunk of money on the latest smartphone today and dry up funds that can be used much more effectively in other applications. 

Instead, you can leverage the power of compounding and divert a significantly smaller amount of funds periodically into a SIP or even a recurring deposit and have a much larger corpus at the end of a few months or a year to spend. Therefore, buying that fancy new gadget today also comes at the cost of not using that amount on other alternatives, such as a SIP or deposit scheme. 

Always consider how much you are losing out on before deciding how to spend or save your money. Suppose you see your savings account has a significant surplus that is rarely used. In that case, you’re missing out on capitalizing upon higher interest rates of deposit schemes or investment instruments. That is your lost opportunity cost. 

Understanding how opportunity costs work can be a beneficial financial habit that will help in the long run.

  1. Working Without a Plan

Not having a budget and reckless spending is another toxic financial habit that you need to leave behind. Having a well-crafted financial plan can help you set financial targets and plan investment portfolios according to your risk profile, allowing you to achieve your financial goals. 

A good financial plan also includes having a good safety net and investments with high liquidity for emergencies, tax planning, retirement planning, etc. 

A monthly budget may seem unnecessary, but you’d be surprised at just how much of our expenses can be curtailed if a well-planned budget is strictly adhered to.

  1. Emotional Spending

Emotional spending or impulsive spending can be yet another toxic financial habit that can potentially wreck your long-term plans. Spending all your income on non-essentials like too many parties or trips can prove to be disastrous if it gets you stuck in a debt cycle. Quite often, people end up surprised when they realize how much they have spent during the year. 

Setting up a reasonable budget with adequate room for a little extra spending can solve many of these challenges. But the most important aspect of having a budget is to cultivate the self-discipline to follow it. It may be hard now to miss out on things, but your future-self and financial portfolio will thank you in the long run.

  1. Not starting savings early

Saving and investing is crucial to everyone’s life. Many young people might assume they can always start investing later and a few initial years of lavish spending would not be a problem. But such an approach can result in a lot of missed opportunities and returns that you may regret later. Saving for things like a trip abroad is different from saving for something like retirement. You should focus on budget cuts and high-interest instruments like fixed deposits or certain categories of mutual funds for the former.

 But for the latter, you must start as early as possible with long-term investment plans. Saving a small amount and starting early is much more beneficial than saving a significantly larger amount closer to when you plan to retire, due to the power of compound interest. If you start early, your capital has had a much longer period to generate interest which accumulates into your capital over the years. This generates higher returns via interest every cycle, leading to a much larger corpus than what you would get following the latter approach.

Source: Federal Reserve Bank of St Louis

  1. Getting Lured by Seemingly Attractive Offers

Sometimes offers that involve loyalty points and premium memberships can end up resulting in a net loss for you. For example, suppose your credit card company is offering you reward points for every $100 you spend. In that case, you may be enticed to spend even more just to earn those reward points, without realizing that it results in unnecessary expenditure that can be diverted to savings. 

Another example can be a premium e-commerce store membership that might cause certain customers to spend even more to compensate for the membership fee. While this does not mean that all such offers result in loss, it is definitely worth analyzing your gains and losses when it comes to such situations.

Your Financial Habits in 2021

It is an open secret that discipline is the key to a successful financial plan. Many toxic habits result from a lack of understanding of how everyday decisions can have larger effects on our lives and how small behavioral changes can greatly benefit us. 

To make budgeting easier and track your spending, manage expenses, set up recurring bill payments, etc., all in one place, apps like Salt are extremely useful in finalizing your financial plans. However, even financial discipline does not need to be taken to the extreme. Not allowing yourself to spend on anything for a bit of fun can also lead to stress. In any lifestyle, figuring out what is best for you and creating the perfect balance between saving and expenditure is essential.

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