“Congratulations Shilpa! So you’ve landed yourself your first job. Time to start thinking about saving for the future.”
“What? Already? I haven’t even got my first salary yet!”
This is a familiar exchange with parents despairing that their children have no idea of what it takes to save for their future. In India, more than half the population is below 25 years of age, while over 65 per cent are below 35. By 2020, the estimated average age of an Indian will be 29 years. Four to five million new professionals below 25 years of age join the workforce every year.
However, the unfortunate reality is that young Indians are likely to face problems meeting their financial needs as they get older. India does not have a social security plan or an old-age financial support system.
Saving and financial planning are nearly as important as doing well in one’s job. There are three fundamental principles that impact one’s money.
Power of compounding: Start saving early. Save something every month — even as little as Rs.1000 — from your first salary. Ideally, it should be at least 8-10 per cent of the take-home pay. Slowly increase it to the maximum you can afford. Put away the money you want to save before you use the rest. Over time, this translates to significant returns on your initial investment. See how incredibly powerful compounding can be.
Consider two friends; Ajay and Vijay. When Ajay was 25, he invested Rs. 15,000 at 5.5 per cent rate of interest compounded annually. At age 50, Ajay would have Rs. 57,200.89 in his account without adding anything to his initial investment.
Vijay did not start investing until the age of 35 when he invested Rs. 15,000 at the same rate of interest compounded annually. At age 50 he will have only Rs. 33,487.15.
Ajay earned a total interest of Rs. 42, 200.89 whereas Vijay earned only Rs. 18,487.15. This was not just because Ajay accumulated more interest but because this accumulated interest was itself accruing more interest. His money was working for him even as it lay in his account. If Ajay had deposited Rs. 15,000 every year, at the same compound rate of interest, the effect would be almost magical.
Inflation: Your money loses value over time due to inflation. A thousand rupees invested at the beginning of a year may be worth only Rs. 930 at the end of the year, when adjusted for inflation at, say, seven per cent. This is effectively a decrease in the time value of money. Your choice of investments should try to beat inflation.
Risk: A bank deposit is usually considered safe whereas shares are considered risky. The younger you are, the greater the ability to withstand risk. Stocks and mutual funds give good returns but the risks can be overcome if one invests systematically and for the long-term.
A lot of how you save depends on where you live and work, if you are living with family or on your own... However, there are some broad guidelines:
Savings: Start saving early. If you live at home and don’t have to contribute to expenses,you should be able to save at least 25 per cent of your salary. If you paying live alone, inculcate financial discipline by saving before spending on luxuries or unnecessary purchases.
Additionally, start building an Emergency Fund by putting aside a small portion of your salary every month. This should go into a fixed deposit, preferably in a Recurring Deposit. This should accumulate enough money to cover your routine expenses and lifestyle for at least four to six months in the event of a family emergency orb loss.
Open a PPF account at the earliest. It is considered to be among the most tax efficient instruments in India. The minimum deposit is Rs. 500 every year and interest earned on deposits are not taxable.
Insurance: Buy a Term Life Insurance Plan for a sum of, say, Rs. 50 lakhs or even one crore. The earlier you take it the cheaper it is. It is wise to take a Health Insurance Plan even if your company provides for it. It will take care of unforeseen health issues. In addition, it also provides tax benefits.
Investments: After this, it’s time to consider investments. Younger persons can allocate a larger chunk of their savings into investments; more so in equities.
Equity Linked Savings Schemes (ELSS) is a type of diversified equity mutual fund that qualifies for tax exemption. It offers the twin advantage of capital appreciation and tax benefits even though it has a lock-in period of three years.
Systematic Investment Plan in a reputed large cap equity Mutual Fund. These should be long-term since it addresses the issue of market fluctuations in the long run.
Remember, insurance policies are not investments.
Credit Cards: Use these judiciously. Beware of making part payments and building up debt. Interest rates are exceptionally high and can eat into your savings. Use the card wisely and make regular full payments well before the due date.
If you get started with these recommendations within the first year of your first job, you would have done well.
