It is well known that the earlier you start saving and investing, the brighter your future will be. “The benefits of starting early cannot be overstated. Building discipline in the early years is crucial for long-term success,” says Sanjiv Singhal, Founder of Scripbox. In this week’s cover story we have identified seven smart money moves that new earners should make. From how to budget to maximising your employee benefits to picking the right insurance, take these baby steps towards a successful financial future.
Ritika Cheema, 25, Mumbai
School teacher, started working four months back
- Started an SIP in a hybrid fund with her second pay cheque
- Has opened a PPF account
- Repays credit card bill in full
NEEDS TO WORK ON
- No knowledge of taxation on investments
- Low equity exposure, mainly invested in debt
1. Track your spending
Figuring out where and how you spend your money is the first step of formulating a budget. It is easy to determine how much you spend on rent, groceries, conveyance and utilities. But you are likely to miss out on the peewee spends. After Sushant Rawat (see picture) signed up with an expense tracker app, he realised how much he was spending on eating out. “Small bills of Rs 250-300 would go unnoticed. But the statement at the end of the month showed how these were eating a big chunk of my income,” says the 23-year old architect.
Experts advise that you should record each and every transaction for a couple of months to get a hang of your spending pattern. “It is better to pen down purchases in a diary, phone or an excel sheet as opposed to mental calculations,” says Amit Suri, a Delhi-based financial planner. Or you can sign up with a money management app such as Chillr, ETMoney or Walnut to simplify your work.
Once you know how much you spend for different things, allocate a budget to each head of expense. “It’s hard to put the brakes on spending when you start earning. Monitoring expenses will ensure you don’t overspend on discretionary items,” says Priya Sunder, Director, PeakAlpha Investment Services.
2. Save for goals, don’t borrow
Apart from smaller discretionary spends, there will be bigger expenses such as a holidays or buying a gadget. Studies show that Gen Y is unafraid to take loans to fund these dreams. “Easy access to credit has led to a paradigm shift in the way the young generation spends, saves and invests,” says Ashish Shanker, Head-Investment Advisory, Motilal Oswal Private Wealth Management. It is no surprise then that IndiaLends, a digital lending company, reported in April 2019 that 85% of the travel loan applications on their platform came from millennials.
However, too much borrowing is a recipe for financial disaster. “The easy option of buying on credit gives a wrong illusion of higher affordability but is also an easy way to slip into a debt spiral,” warns Shanker.
Personal loans are one of the costliest forms of borrowing, charging 20-24% interest per annum. Credit cards are even costlier and can become a burden if not used judiciously. As a rule, do not spend more than 30% of your income at a time on repayments. Cheema has done exactly this. “I have capped EMI financing at 20% of my salary,” she says.
If using credit cards, make sure to pay the bill in full by the due date every month. Failure to repay even a part of the monthly bill will attract additional interest on the overdue amount as well as on every new swipe. “Rolling over the due amount can disturb your monthly budget. Interest on rollover balance can be as high as 40% per year,” Mehta adds. If you don’t have the discipline, stick to debit cards.
The most effective way to save for your big-ticket expenses is to stash away a fixed amount at the start of every month in a savings account. “The idea is to make monthly saving precede other expenses,” says Mehta.
If you want to plan for a goal 3-4 years away, say a car or higher education, you should consider investing the savings in a hybrid fund for capital appreciation. Goals can categorised as short-, medium- and long-term according to investment horizon and saved for accordingly (see graphic). Instead of saving blindly, calculate the exact corpus that you will need for your goal.
CHART OUT YOUR GOALS AND START SAVING
1. Short-term goals (1-3 years)
Foreign vacation, expensive gadget, emergency fund
Liquid fund, short-term debt fund, recurring deposit
Since the funds are required soon, stick to debt instruments. The aim is not to chase returns but to ensure liquidity and preserve capital.
2. Mid-term goals (4-6 years)
Higher education, car, house
hybrid fund, corporate bond funds, ELSS, fixed deposits
For a medium term of 4-6 years, strike a balance between risk and returns. Corporate bond funds invest in highly rated corporate bonds with 3-5 years maturity whereas hybrid funds provide some equity exposure for capital appreciation.
3. Long-term goals (Over 6 years)
House, wedding, retirement, wealth creation
Equity funds, NPS, Ulips, PPF
A longer horizon of over 6 years can brave market volatility. Equity exposure is a must in your portfolio to tackle infl ation and for capital appreciation.
3. Create an emergency fund
Financial planners insist that setting up an emergency fund should be a top priority. “Unexpected expenses keep cropping up and availability of funds is always a problem with youngsters leading fast paced lifestyles,” says Rohit Shah, Founder and CEO, Getting You Rich. An emergency fund is meant to help you tide over unforeseen expenses, such as vehicle repairs, a broken phone, a medical emergency or even a job loss, without having to borrow.
You might even want to take an extended leave to pursue a passion, during which time this pool of savings will be useful. “Youngsters are increasingly becoming experimental with their work preferences and do not hesitate in leaving their current job to explore other options. With a contingency fund in place, they can take this leap without worrying about financial commitments,” says Mehta of Upwardly.
“The emergency corpus should be equal to 3-6 months’ of your expenses,” says Shah. The size of the corpus can vary as per your financial situation. “If you have loan repayments or rent to pay, set aside at least 6 months’ worth of expenses. However, in the absence of any financial obligations, 2-3 months’ expenses should be adequate,” says Sunder. Rawat wants to take some time off from his job to start his own venture and is not worried about funding the monthly expenses in absence of a salary. “My emergency fund will easily for cover six months,” he says.
The money should be accessible to you at a short notice so save it in a liquid fund or a recurring deposit (see graphic).
Sushant Rawat, 23, Dehradun
Architect, working for past 1 year
- Has a contingency fund
- Budgets with a 30-40-30 (utilities-savingdiscretional) rule
- Saves and spends instead of swiping plastic
NEEDS TO WORK ON
- Does not have health insurance
- Savings of over Rs 2 lakh is idling in bank
4. Have a blow it away fund
“Early days of career are for the joys that money can bring,” writes Uma Shashikant, Chairperson of Centre For Investment Education and Learning. This sums up the importance of having fun every now and then while you are young and have less responsibilities to worry about. As part of budgeting, after you have paid all the bills and saved for emergencies, reserve 8-10% of your income for unbridled spending. Buy that expensive pair of shoes or splurge on a concert if you want to.
The important thing is that you don’t overdo the fact that in the absence of financial liabilities, you are allowed to spend. And at any cost, don’t borrow or swipe plastic frequently to fund your desires. “The more practical advice to give youngsters is that they manage their spending within the available resources and not to get them to start investing early at the cost of their desires,” says Sunder.
5. Pick the insurance you need
Buying insurance, both life and health, early comes with cheap premiums. But experts say that picking the right insurance at the start of your career should be a function of your needs and not the premium amount. “Don’t buy life insurance early when there are no dependents just to lock into a low premium. Insurance without need will just be an additional cost,” says Shah. However, if you are repaying an education loan, buy a term plan with a cover equal to the loan amount at the earliest.
The other type of life insurance is endowment plans that get sold the most to young earners towards the end of the financial year for tax saving. Endowment policies are typically pushed as a product that offers triple benefits of providing insurance, tax saving and wealth creation. In reality, returns on traditional plans are less than 5-6% and you end up with an insufficient cover for a huge premium. Gurgaon-based professional Anurag Sharma is paying a hefty premium of Rs 58,000 for a traditional plan his father bought in 2007.
Anurag Sharma, 25, Gurgaon
Consultant, started working at 23
- Invests Rs 6,000 per month in an ELSS fund for tax saving
- Automated all his bill payments and investments to establish discipline
- Charted out short and long term goals
NEEDS TO WORK ON
- Has only employer’s health cover
- Doesn’t have a dedicated emergency fund
You should look at buying health insurance instead. “When you are young and healthy, premium will be low and the underwriting is less strict,” says Sunder. Buy a basic indemnity plan, which covers hospitalisation charges, to begin with. Add accident disability plan to your insurance kit if you want to enhance the coverage.
6. Pay off your education loan
For those who are entering the job market with an education loan, the importance of increases manifold. Experts say that even though it’s a ‘good loan’, repayment should be a priority because it’s a loan nevertheless. “Interest component in a loan is the real burden. One should try to minimise and repay at the earliest,” says Suri. Moreover, the tax deduction under Section 80E on the interest paid is available only for the first eight years.
With fewer liabilities and higher disposable income, it is not difficult to direct big amounts towards loan repayment. Experts say borrowers should refrain from taking other big-ticket loans for a few years because that can stretch their finances.
7. Learn about tax saving
There is no tax on individuals earning up to Rs 5 lakh a year. Most people in their first jobs will come under that bracket. “Those with an annual income in the range of Rs 6-7 lakh should prioritise tax planning to bring down their net taxable income below the Rs 5 lakh threshold,” says Singhal.
However, experts say one should not invest only to save tax. “Also check whether the tenure of the product matches with your investment horizon and the liquidity that it offers,” says Singhal. For instance, NPS does not allow withdrawals before the age of 60. It is also important that you consider returns on your investments along with tax saving. For instance, ELSS funds make your investment grow along with letting you save tax. 60% of Sharma’s investments are in ELSS funds. “I have kept PPF contribution to minimum because I want to have maximum exposure to equities,” says the 25-year-old.
Some companies allow employees to design their pay packages while others offer certain tax-free options. You can save tax if you understand how these tax saving options work. For instance, food coupons are tax exempt and can be used to buy food items from selec outlets. The NPS benefit under Sec 80CCD(2) is another option that can help you save big. Sharma did not pay much attention and paid Rs 54,000 tax in his first year. But he has now managed to reduce his taxable income to the 20% tax bracket (below Rs 10 lakh) by investing in various tax saving options.
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