Imagine this – you got your first pay cheque. That’s an incredible feeling for most of us, wouldn’t you agree?
You end up spending the money for buying gifts for friends and family, managing your day-to-day expenses, or treating yourself with that latest gadget you couldn’t afford – for a job well done.
That’s OK with your first salary; but is all your subsequent salary being spent the same way?
Early in our career, most of us don’t plan our finances. But remember this; the early bird gets the worm, and the early saver, gets a comfortable financial life.
Saving and financial planning are nearly as important as doing well in your field of work. Proper planning will help you realize your financial goals such as a house or a car.
Three basic financial concepts that impact your money
# 1. Compounding and time: Just like a tree that grows over time, your money also has the potential to grow.
Here’s an example that illustrates the point. You invest Rs 10,000 at a fixed interest of 10%. At the end of the year, your total investment value is equal to Rs 11,000 (Rs 10,000 principal + Rs 1,000 interest). Now, even if you stop investing at this point, at the end of year 2, your investment value will be Rs 12,100 (Rs 11,000 principal + Rs 1,100 interest).
Did you see how the Rs 1,000 you earned as interest in the first year earned an additional Rs 100 in the second year? That’s your money working for you. This is what is referred to as compounding.
Over a period of time, you can earn significant returns from your small initial investment. You can use a simple online calculators to figure out how much you current investment will compound to.
Expert Tip: Even if you have only little money to invest, start early. The small amount of money can surprisingly grow to a large amount by the time you actually need it; thanks to the power of compounding.
# 2. Inflation: Where compounding helps, Inflation doesn’t. Things become expensive overtime due to many reasons. This rise in prices of essential commodities is called inflation.
Now, how fast your money grows, in relation to inflation is what determines how your wealth grows.
Your money loses value over time thanks to inflation. So Rs 10,000 invested in January of this year may be worth only Rs 9,200 at the end of the year, if inflation is at 8%.
An investment returning 8% when inflation is 8% is doing nothing but keeping your money where it was.
Expert Tip: When you calculate returns, take tax implications into considerations. An investment returning 8% without attracting any tax is most likely better than an investment offering 9%, fully-taxed.
# 3. Risk: Nearly every investment comes with risk, but it’s worth taking to ensure you beat inflation. A bank deposit is generally considered the safest whereas shares of a company are considered risky.
Generally, the younger you are, the greater will be your ability to withstand risk. Stocks and mutual funds give good returns but do come with some risks although the risk is very low for long-term investments.
Expert Tip: Don’t be overly obsessed with your risk profile. Our belief is that your personal risk profile does not really matter. It’s the risk profile of your goal that matters.
How to make a financial plan?
# 1. List your assets and liabilities: List what you own versus what you owe. Your motorcycle is an asset. Your education loan is a liability. The difference is your net positive or negative financial worth. This will give you an idea of your financial status at the moment.
# 2. Your income is your revenue: Your salary or profits is what you make and where your savings will come from.
# 3. List your expenses: List all your expenses for the month. This will tell you where you are spending your money and where you can cut costs.
# 4. Start saving something: It can be as little as INR 1000. Get into the habit of saving from the very beginning. Try and save around 10% of your income to begin with. Slowly increase it to the maximum you can afford to save. Remember: Save first before you start spending.
#5. Create an emergency fund: Experts believe that you should create an emergency fund that has 3-6 months of expenses. This will help you deal with possible layoffs or unforeseen emergencies. You can put your initial savings in this.
#6. Once you have created an emergency fund, list your financial goals: An emergency fund should be your first goal. After this, list down your goals under long term, short term, and medium term heads. Long term goals can be a house, medium term can be a car, and short term can be a smart phone.
# 7. Start investing in mutual funds: Mutual Funds are generally considered to be the safest way to invest in the share market. Debt mutual funds are good for short term goals (3-5 years) whereas equity mutual funds can give inflation and market beating returns in the long run (5-10 years).
#8. If you have dependents, get insured: If you have any dependents, it is a good idea to get insured for a sum that is 20-30 times your annual earnings. Insurance is an expense and not an investment. We recommend buying term plans only.
#9. Get health insurance: Healthcare costs are rising fast and having an effective health insurance policy can come to your aid in case of emergencies.
#10. Choose your investments carefully: Choose investments options based on how long you can remain invested for.
For example, if you are planning for your retirement and can stay invested for 20 years, then you should choose an investment that delivers inflation beating returns. Equity mutual funds fit these requirements.
However, if you want to stay invested only for 1 year, then debt funds or bank FDs provide reasonable return with less risk.
#11. Review your investments periodically: Monitoring your investments periodically is always a good idea. This will help you understand if your investments are growing as they should or if you need to change your investment strategy.