It’s never too early to start planning your finances, but it can get too late. So if you are turning 30 and haven’t taken the investment path yet, get going before it actually gets late. As you grow older, certain financial products become more expensive or even inaccessible in some cases. Apart from this advantage, starting early would ensure you have more number of “investing” years.
Says Kartik Jhaveri, founder and director Transcend Consulting (India) Pvt. Ltd, a private wealth management company, “Young people (below 30 years) are busy living their lives and don’t really think about saving or financial planning. It’s only when they realize that they want to buy a house that they start thinking on those lines and that happens with the start of a family.” But starting when you do not have family liabilities would ensure you are well prepared to have a financially secure family. Here are four things you must look at.
Rationalize your debt
Credit cards: If you are a single working professional in a city, it’s more than likely that among clothes, movies, night-outs and lavish dinners, that credit card bill has got inflated. While that in itself isn’t an issue, over-extending your credit period on a credit card is. Over-extending credit in some cases can translate into taking a loan at an interest rate of around 39% per annum.
Says Rajiv Bajaj, managing director, Bajaj Capital Ltd, “A number of people who come to us are highly debt-ridden. As part of our process, we do a scenario analysis to see what future finances would look like before and after financial planning. In many cases people are headed for a financial mess without the help of proper planning.”
Get rid of this habit of carrying forward your credit card dues beyond the 50-day credit cycle. Not only will you have to pay late charges, but also finance charges or interest on the amount outstanding. And it’s not even okay to pay the minimum charges only and carry forward the rest of your dues; that too means you have to pay interest on the remaining amount at a monthly rate of 3-3.25%.
Sample this: If you carry forward an outstanding amount of Rs1 lakh and only pay the minimum amount due, at the end of six months, you will still have an outstanding balance of Rs89,366 despite having repaid Rs28,641 (monthly minimum dues).
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Personal loans: Many take personal loans early in life for immediate expenses. Pay back all those loans and stop taking any more. Here too you are paying an interest rate as high as 18-20% per annum (or more), which can substantially eat into your monthly surplus, which can be better utilized in investments rather than loan repayment.
Home loans:Housing loans are of less concern as it is an asset that appreciates in value. But remember don’t stretch your finances too tight on that loan, too. Real estate is a relatively illiquid asset and can’t generate cash immediately.
By Shyamal Banerjee/Mint
Life insurance: Whether you are single or married, life insurance is a smart thing to do to cater for your dependants and loved ones. Pure term insurance plans that come with a sum assured, which gets paid to the nominee in case the insured dies, but otherwise generate no returns are the cheapest and simplest form of life cover.
Starting early on insurance means you will be able to get a low premium on a relatively high sum assured. Says, Pranav Misra, executive vice-president (sales and distribution), ICICI Prudential Life Insurance Co. Ltd, “Life insurance is about sharing risks, so younger people benefit as the mortality charges are lower. Therefore, protection can be procured at lower prices. This stands true across life insurance products—whether it is pure protection or protection with returns.”
The existing premiums for life insurance policies don’t change as you grow older, so starting early is a definite advantage. Typically, term plans are available till 60-65 years of age. While arriving at the sum assured, you need to factor in your age, number of dependants and lifestyle changes. As a rule of thumb, financial planners recommend that you have insurance cover equal to 12-15 times your annual expenses or 8-10 times your annual income. However, if you have debt riding on you, then factor in that, too.
Health insurance: This is one policy that every individual must have, especially given the soaring cost of medical bills.
If you are a working professional, there is a good chance that your employer provides you a health insurance policy. Usually, group insurance policies are relatively more flexible since the insurer covers not an individual but an entire group. For instance, most group insurance policies cover pre-existing diseases, too.
But depending solely on that is not advisable. Says Sushil Jain, certified financial planner and head (financial planning process), Bajaj Capital, “There can be concern if you are in between changing jobs or the new company doesn’t provide the same plan or doesn’t provide for a pre-existing illness.”
The insurance regulator has now allowed you to port your group health insurance policy to individual health insurance of the same insurer. After a year, you can change the insurer but be cautious. When moving from group health insurance to individual health insurance, it is the number of years of continuous coverage from your group insurance that is portable. For instance, if you have been covered under a group cover for two years and then decide to port your policy to an individual health insurance, having a waiting period clause on pre-existing diseases of say four years, the new policy will waive off two years of the waiting period. Also, if you have already made a claim on account of a medical condition under your group policy, the ailment may be considered a pre-existing disease in the new policy and you may have to serve the waiting period in full. Alternatively, the insurers may charge extra to cover the disease.
Remember that if the insurer refuses to cover you under its individual health insurance in case you do not fit the underwriting standards of the insurer and you change your job, you would be left without a cover and would have to approach another insurer.
Mint Money recommends a basic health insurance policy that pays your hospital bills and reimburses expenses incurred before and after hospitalization. Most health insurance policies these days are cashless in their network of hospitals. Apart from having individual covers a family can also consider buying floater policies. A family floater policy treats the entire family as one unit. But here the sum assured reduces if one member invokes a cover (reduces by that amount). It’s best to take the family floater as an add-on to individual health covers for each member.
Have a diversified investment portfolio
Once you have cleared your unnecessary debt and taken adequate insurance, it’s time to consider an effective investment portfolio. The sooner you start investing, the more returns you are likely to make in the long term, thanks to the power of compounding.
Moreover, when you are younger, you have fewer financial responsibilities and are likely to save a larger percentage of your income. As children grow older, education costs creep up along with the need for a bigger house and better amenities, squeezing your saving potential.
Says Jhaveri, “Typically, people start with tax saving-linked investments. Start simple instead. Go to a bank, understand interest payments and then move on to products such as recurring deposits. Do that for some time and then increase your risk quotient and graduate to systematic investment plans (SIPs) in equity.”
At 30, if you invest Rs2,000 per month, assuming your portfolio (mix of debt and equity) earns 10% per annum, you will have a corpus of Rs1.55 lakh at 35 years and Rs5.18 lakh at 50 years of age. If you start investing at age 40, assuming you have a higher surplus, even if you invest Rs5,000 every month, given a 10% per annum return, you will have only Rs10.24 lakh at 50.
Also, remember to invest across asset classes depending on your risk profile and return requirement. Being over-invested in equity can make your portfolio too risky and investing too much in fixed income can mean that you earn too little owing to inflation. For example, an equity allocation of 60% reflects a fair amount of risk, whereas 50-60% in fixed income is considered a conservative strategy. Real estate can make your portfolio illiquid.
Plan your retirement
If you are in your 20s or in early 30s, saving for the sunset years may seem premature. You may argue there is ample time to plan retirement, but the sooner you start the less taxing it will get in the subsequent years. As demonstrated in the example above, this is due to the magic of compounding.
Says Jhaveri, “Financial prudence says retirement planning should start the day you begin earning.” This is especially relevant nowadays, given that many wish to retire early to pursue personal interests.
To begin with, have a target corpus in mind and complement it with cash flow discipline. Your retirement corpus depends on retirement age, desired standard of living, inflation, taxation and your current investments. Keep these in mind to arrive at a potential future cash balance; take the help of a financial planner to do the calculations so that you are reasonably certain of where you are headed.
Says Jain, “You can inflate on present cost of living to the age you want to retire and arrive at a corpus to cater for the years after retirement. Keep this corpus separate from other goals such as children’s education and marriage.” The idea is to get started and tweak the plan as you go ahead. The plan needn’t be rigid, but you should be on the right path.
The next step is to choose the assets and products that will help you reach the target you have set. Thumb rule: the younger you are, the more exposure to equities you can take. But in addition to equity investment, you must also consider some debt products.
If you are a working professional, maximize your Employee’s Provident Fund (EPF) contribution. EPF has consistently outperformed other debt products in the retirement space. A risk-free instrument, it has been giving tax-free returns of 8.5% for some time now; in FY11 due to a surplus it declared a rate of 9.5%. The next in line is Public Provident Fund (PPF). Again a zero-cost, risk-free and tax-free debt product. For quite some time, PPF has been giving 8%; from this year, the rate will be pegged to the yields of government securities. Other than these, you could also consider National Pension System (NPS). At a fund management charge of 0.0009% per annum, it is the cheapest managed fund in the industry. Even the structure of the NPS instills discipline while saving for retirement since it locks in your money till 60 years of age. At 60, you get the corpus, 40% of which you have to mandatorily invest in an annuity or a pension product.
So go ahead and build a strong financial foundation.
Graphic by Yogesh Kumar/Mint