 "Mistakes to avoid on receiving lump sum amount")
With government announcing the Seventh Pay Commission, consumer goods companies and developers are expecting their sales to get a boost. Investment managers are betting on consumption sector to do well. This reflects the spending habits of individuals when are about to get a salary hike, arrears or bonuses. When a person is expected to receive a lump sum amount, the first thought is either to buy something or settle existing debt. Very few actually think about saving it for their financial goals.
Prakash Sawant, a state government employee, plans to redo his house if there are arrears. One of his colleagues is planning to buy a car and another one has booked a vacation in the last week of December on credit card hoping to repay when the hike/arrears are doled out. But entirely spending lump sum amounts, instead of utilising them to meet your goals, can impact a person's financial health.
Here are some common mistakes that a person usually commits when he or she is about to receive a lump sum amount.
Absence of long-term planning
Every person has to take a look at their financial situation and then plan for different goals. These can range from ones that are few weeks away to those that stretch for decades. Usually, individuals do financial planning on a piecemeal rather than opting for a comprehensive plan. On receiving lump sum payment, they can allocate the money to their short term as well as long term goals and achieve them faster. Most, however, think about ways to spend it and struggle to meet their goals.
A person, therefore, needs to first plan the allocation of money to ensure that it's not spent immediately. Don't fall for the usual trap, where individuals later regret that they should have used the money wisely. Some do plan but only for the near term. Planning is good but not thinking long term is not.
Spending more than receipts
Many a times, when people know that they are going to get a particular amount in the near future; they use credit cards to buy things even before the money actually is credited to the bank account. There's a comfort that they will repay the card company as soon as they receive the money. But in this process, they usually spend more than they would receive. And later, they struggle to pay back their debts.
They also don't realise that there will be tax impact on the money they are going to receive, and that the employer would deduct the tax at source before payment. They spend thinking about the gross amount and end up with lower sum than what they had anticipated. If a person in 30 per cent tax bracket is getting Rs 3 lakh in arrears, the tax deduction can be as high as Rs 90,000.
Another mistake that many make is shifting their goal posts. Take a simple case of a person wanting to buy a new car from a lump sum that they would get. The original goal would have been to buy a certain model that costs, say Rs 5 lakh. Initially, the savings are done for this amount. When they actually receive the lump sum, they end up spending more. In this case, when actually buying a car, they may end up choosing a model with additional features increasing the car cost, and would end up paying, say Rs 5.8 lakh.
Creating future liabilities
There are also situations when people end up creating future liabilities when they receive the lump sum amount, damaging their finances. In the above example, there are many who might opt for a bigger car than what they had actually planned by taking a loan. This typically happens because the person may get lump sum in arrears and also a salary hike. What they don't realise is that the equated monthly instalments would negate the increment received.
The damage can vary from few months to years depending on the liability. If there is an outstanding on credit card, it might be paid off quickly in a few months. But car or home purchases on loans run into years, before they are paid off. One should only change goalposts if there's additional buffer available to service liabilities, and the decision has been properly thought through.
Forced spending
It's very easy to look at others spending and follow the suit. These days it's common to see individuals upgrading their mobiles regularly looking at their peers. Many get their children gadgets because all their friends own it. Lump sum payments are frittered away in such purchase. Any large spending should be need based, without compromising on the goals.
A person should rather look at spending on essential items first; say for education needs of the children or purchasing necessary household items that are pending because of lack of funds.
JUDICIOUS SPENDING
The writer is a certified financial planner
Prakash Sawant, a state government employee, plans to redo his house if there are arrears. One of his colleagues is planning to buy a car and another one has booked a vacation in the last week of December on credit card hoping to repay when the hike/arrears are doled out. But entirely spending lump sum amounts, instead of utilising them to meet your goals, can impact a person's financial health.
Here are some common mistakes that a person usually commits when he or she is about to receive a lump sum amount.
Absence of long-term planning
Every person has to take a look at their financial situation and then plan for different goals. These can range from ones that are few weeks away to those that stretch for decades. Usually, individuals do financial planning on a piecemeal rather than opting for a comprehensive plan. On receiving lump sum payment, they can allocate the money to their short term as well as long term goals and achieve them faster. Most, however, think about ways to spend it and struggle to meet their goals.
A person, therefore, needs to first plan the allocation of money to ensure that it's not spent immediately. Don't fall for the usual trap, where individuals later regret that they should have used the money wisely. Some do plan but only for the near term. Planning is good but not thinking long term is not.
Spending more than receipts
Many a times, when people know that they are going to get a particular amount in the near future; they use credit cards to buy things even before the money actually is credited to the bank account. There's a comfort that they will repay the card company as soon as they receive the money. But in this process, they usually spend more than they would receive. And later, they struggle to pay back their debts.
They also don't realise that there will be tax impact on the money they are going to receive, and that the employer would deduct the tax at source before payment. They spend thinking about the gross amount and end up with lower sum than what they had anticipated. If a person in 30 per cent tax bracket is getting Rs 3 lakh in arrears, the tax deduction can be as high as Rs 90,000.
Another mistake that many make is shifting their goal posts. Take a simple case of a person wanting to buy a new car from a lump sum that they would get. The original goal would have been to buy a certain model that costs, say Rs 5 lakh. Initially, the savings are done for this amount. When they actually receive the lump sum, they end up spending more. In this case, when actually buying a car, they may end up choosing a model with additional features increasing the car cost, and would end up paying, say Rs 5.8 lakh.
Creating future liabilities
There are also situations when people end up creating future liabilities when they receive the lump sum amount, damaging their finances. In the above example, there are many who might opt for a bigger car than what they had actually planned by taking a loan. This typically happens because the person may get lump sum in arrears and also a salary hike. What they don't realise is that the equated monthly instalments would negate the increment received.
The damage can vary from few months to years depending on the liability. If there is an outstanding on credit card, it might be paid off quickly in a few months. But car or home purchases on loans run into years, before they are paid off. One should only change goalposts if there's additional buffer available to service liabilities, and the decision has been properly thought through.
Forced spending
It's very easy to look at others spending and follow the suit. These days it's common to see individuals upgrading their mobiles regularly looking at their peers. Many get their children gadgets because all their friends own it. Lump sum payments are frittered away in such purchase. Any large spending should be need based, without compromising on the goals.
A person should rather look at spending on essential items first; say for education needs of the children or purchasing necessary household items that are pending because of lack of funds.
JUDICIOUS SPENDING
- Lump sum receipts require thorough plannin
- Don't spend more than the expected amount
- Do calculate the tax liability on the money you will receive
- Don't change the original budget on expenses because lump sum amount gives you a buffer
- Do not create future liabilities by adding unplanned loans
- Spend only on essential items
The writer is a certified financial planner