You are young and healthy. You want to splurge on the latest mobile phone, an expensive watch or a large screen TV. Saving is not your priority and financial planning is not on the top of your mind. Well, the biggest mistake most youngsters, like me, make is not talk about their finances and investments. Remember the more you delay things, the more you will have to save monthly later on. For example, if you are 20 and want Rs.5 crore by the time you are 60, you will have to save just Rs 4,207 a month for the next 40 years, assuming the rate of return is 12 per cent. If you are 25 then you will have to almost double your savings, ie, Rs. 7,698 every month for the next 35 years. It is, therefore, important to understand the need of saving regularly from the beginning. Here are a few tips on how you can manage your finances better.
- Identify your goals
Before you start investing, always ask what do you want to save for. Is it for your retirement? Is it for buying a house? Experts say identifying goals help people in contributing regularly towards their goals. Aimless investing sometimes prompts people to break their investments and use it for less important things. For example, the money which you have been using to build a house should never be used to buy a car. Goal-oriented investments also help in making the right choices. For example, if you are young, you could invest a large portion of your savings in equities. Past performances indicate that equity tends to perform better than all other asset classes in the long run.
- Make a budget
You should have an estimate of your monthly expenses. How much your family spends on groceries? How much goes on entertainment? etc. The best way is to prepare an excel sheet and list down all your monthly expenses. There are various apps that help you track your budget. Once you figure out how much your monthly expenses are, you will find yourself in a better position to invest your money.
- Create an Emergency Fund
Emergencies, such as a job loss or an accident, come unannounced. You need to maintain a contingency fund for such solutions. The thumb rule says that you should set aside at least six months of your take home salary as an emergency fund. The next question is where to invest. You can park your emergency funds in those liquid assets that can be turned into cash quickly without the loss of principal. You can out some portion in savings account linked to fixed deposit or liquid funds. It is also advisable to put around 10 to 15 days monthly expenses as cash at home to meet emergencies, such as floods, sudden hospitalization, among other things.
- Buy Insurance
When an earning member of the family dies, the whole family suffers a setback. It is , therefore, important to buy a life insurance policy. The question is how much cover should one have. The ideal figure, say experts, is at least 10 times the annual salary. This will give the family a cushion of 10 years to adjust to the new financial reality. For example, if your annual salary is Rs. 10 lakh, the cover should be at least Rs.1 Cr. Similarly, considering the medial inflation is as high as 15 to 16 per cent, you need a health insurance policy with an adequate cover.
- Start Early
Starting early has many advantages. If you do that, your money gets more time to grow. Each gain generates further returns called compounding which can grow money exponentially over time. For example, if you start saving Rs. 5000 per month at 20 and earn 12 per cent returns annually, you will have Rs. 5.94 crore when you retire at 60. But if you start at 30, you will be able to accumulate just Rs. 1.76 Cr. The 10 additional years that give you give your money to grow can do wonders for your financial well being.
- Diversify your Portfolio
Do not invest all your money on one basket. Invest in a mix of products so that your portfolio is not affected if one asset class is down. For example, don’t put all your money in gold. Gold has given just six per cent over the last five years. Similarly, if you just invest all your money in real estate, you might face difficulty in liquidating the money.
- Save for Retirement
One common mistake people make is not saving for retirement. You should start saving for retirement as early as possible to benefit from compounding. Never withdraw from Employees’ Provident Fund, or EPF, unless it is very important as you save it for your retirement. Open a Public Provident Fund, or PPF account and also invest in equities.
- Flight Inflation
It is important to understand the impact of inflation on your financial goals. Inflation reduces your purchasing power substantially. Assuming a seven per cent inflation, Rs 1 lakh today will be worth Rs 13,000 after 30 years. Ignoring inflation means you will save much less than what you will need years down the line. If you spend Rs 50,000 every month at 30, you will need Rs 3.81 lakh a month at 60, assuming annual inflation rate of seven per cent. You have to invest in such a way that you beat inflation, i.e., earn returns that are at least a couple of percentage points above the inflation rate.
- Control Debt
Pay your credit card and other pending bills on time. The interest rates on credit cards are very high. So instead of piling up, get rid of the debt first.