Dreams, these days, come with a high price tag. In fact, seemingly simple needs have been elevated to dreams due to the high cost associated with them. You require either a large income or a strategic plan to meet these basic life goals. Make a financial plan the day you start working and you won’t have to scramble to fund each aspiration.
However, it may not be as easy as it seems. “I don’t know how much to save and where to invest, so I don’t budget and end up spending a lot,” says Harshinder Kaur, who started working two years ago as a probationary officer at a bank. This is a predicament many youngsters in their mid-20’s face. The twin behavioral devils of ignorance and procrastination push most people into their 30’s before they get down to streamlining their finances. This often results in faulty investment choices, flawed portfolios, unmet goals and financial insecurity later.
“This category is not a cash cow for advisory firms, and as they have no one to turn to, they often get lost,” says Jayant Pai, CFP and Head, Marketing, PPFAS Mutual Fund. We try to remedy this through our story this week. We offer the newly employed youth a step by step guide to plan their finances. However, this is merely intended to propel them into planning and they will need to research and learn continuously throughout their working lives.
Make a budget & start saving
Budgeting is the simple exercise of reconciling your income with your expenses, and should be your first step. Note down your monthly spending as per your ease of usage: Excel sheet, simple diary, mobile app, or desktop. The aim is to know how much you spend under various heads. After you have budgeted for 3-4 months, you will realise that your expenses can be sorted into three categories: essential, discretionary and entertainment. “Tracking of budget is important not only to identify mandatory and discretionary spends, but also ensure that you don’t overspend,” says Vinit Iyer, CFP & Founder, Wealth Creators Financial Advisors.
Once you’ve identified the outgoing amount, put away 10-20% of your salary every month before you start spending. If you don’t know where to put it, start with your bank account. Try to opt for a sweep-in account that has a fixed deposit linked to it as it will fetch you a rate higher than 4%, which you get from your savings account. This will help inculcate a lifelong saving habit. As financial planner Pankaaj Maalde says, “It’s important that your money does not lie idle.” This is because with very few liabilities and responsibilities, this is the ideal period to save and take advantage of the power of compounding. Another first is to start educating yourself about personal finance. The more informed you are, the better your decision-making.
Frame your financial goals
You have started saving, but will you have enough to buy a house 10 years down the line, or a car five years hence? People save aggressively and invest with extreme vigour, but do so blindly, jeopardising goals. This is a mistake common to most investors, irrespective of age. The next step then is to frame your goals.
Don’t just make a mental note of the things you want to finance, but write these down in detail. Split your goals into three categories: short, medium and long-term. Then list each clearly, along with the number of years to achieve each, and the exact amount you will need.Once you have penned down your goals, you will be able to determine how much and for how long you will need to in-vest.
Don’t forget to factor in inflation while calculating the amount since it will shoot up the value of your goal. “The nature of your income, earning capacity in coming years, dependants, loans and personal priorities must be considered while framing goals,” says Pai. These milestones may alter with your changing circumstances, say , after getting married or having children. You will then have to make necessary adjustments.
Invest in right instruments
The biggest dilemma that young earners face is where to invest their money. “To start, choose simple instruments like a recurring or FD. Once you have prioritised your goals, think about converting savings to investments,” says Maalde.
The investment vehicle should be chosen in line with your goals and time horizon. “If it’s a short-term goal, keep it in debt; if it’s for the long term, it should be mandatorily equity,” says Kartik Jhaveri, Director, Transcend Consulting. The medium-term goals should have a mix of debt and equity .Debt will offer you the safety of capital since you need it in the short term, while equity has historically given the highest returns in the long term.
For near-term goals, opt for recurring deposit, liquid funds, FDs or short term debt funds. For the medium-term, you could choose balanced funds and equity-linked saving schemes. For the long term, equity funds, NPS, PPF and EPF can be your instruments of choice.
Maximise tax savings
Saving tax is not a priority for most new earners because the salary is not too high, nor the knowledge regarding taxability of instruments. “Do not be obsessed with investing just for saving tax as some expenditures may be useful,” says Pai.
However, it is important to brush up your tax awareness at the earliest. Start with avenues that offer tax deduction of `1.5 lakh under Section 80C. Some of these include the EPF, PPF, NPS, 5-year tax-saving fixed deposits, ELSS, Ulips, life insurance, etc. Then opt for investments that fit in with your goals and needs, or those that are being made by default. The latter could include EPF or the NPS. “You could also use insurance and healthcare-related expenses for dependants astutely ,” says Pai. These would include premium spent on health plans under Section 80D, which is up to Rs 25,000 for self and dependants, and Rs 30,000 for senior parents. Also, calculate returns from your investments after considering the tax.
Opt for the right insurance
The basic purpose of insurance is to cover risks in your life. While you may not feel much need for any kind of cover when you are young, it’s best to know about the various types at the start of your financial life (see chart).
Life insurance: Term plans offer a big cover for a small premium, but you do not get any returns. Then, there are traditional plans, which include endowment and money-back policies.These offer small covers for a high premium, and low rates of return. Finally, there are Ulips, which are market-linked insurance plans with a lock in period of five years and provide a low cover for a high premium, but offer market-linked returns. At this point, the only life cover you may need is a term plan, but this too, only if you have financial dependants.
Health insurance : The broader categorisation includes the basic indemnity plan, which covers hospitalisation expenses, for an individual, and the family floater plan, which includes your entire family in a single cover.
You should have Rs 3-5 lakh basic health plan at this stage. If your company insures you for Rs 2 lakh, buy a top-up plan for `3 lakh as it will be cheaper than a regular policy. Consider a family floater plan only after marriage and kids; don’t include your parents because the premium is determined by the age of the oldest member. Also, don’t just consider low premium as a criterion.