They told you in school that the early bird got the worm. In college, the sermon was, well begun is half done. Just when you thought you had had enough of these preachy one-liners, ET Wealth has decided to goad you into action. Our message is simple: the investment decisions you make in the first 5-6 years of your career have the potential to transform your financial future. We list out eight smart money moves that investors should make before they turn 30.
There are obvious advantages of starting early. Most of us know that the longer we stay invested, the greater is the power of compounding. So, if you save Rs 5,000 a month in an option that earns 10% annually, your corpus at the end of 30 years would be a massive Rs 1.08 crore.
Your principal investment of Rs 18 lakh grows six times. Now, here's the surprise. What you save in the first five years accounts for Rs 48 lakh (over 44%) of the corpus. The Rs 60,000 you put away in the first year alone grows to Rs 10.4 lakh, or 9.6% of the total amount. Miss these wonder years of compounding and your corpus would be much smaller at Rs 60 lakh.
How many investors realise this simple arithmetic? Not many, according to a study by Ameriprise India. The financial planning company spoke to nearly 700 upwardly mobile investors across six major cities in India and found that most of them had frittered away the early bird advantage. The investors in Mumbai understood the benefits of early investing best, with more than 80% of the respondents having started before they turned 26. In Delhi, on the other hand, only one out of woke up to this fact, while in Hyderabad, only one in five did.
Our cover story is intended as a wake-up call for Gen Y. If you have just started your career, you will find these tips invaluable. Whether it is buying pure protection cover early in life or signing up with a portfolio tracker to plug money leaks, these smart financial decisions will lay a solid foundation for a prosperous tomorrow.
1) Take a term insurance policy
Buying a term plan tops the list of smart money moves. The earlier you buy life insurance, the lower is the premium. "It is best to lock in at a young age when you are hale and hearty," says T R Ramachandran, CEO and managing director, Aviva Life Insurance.
We did some number crunching and found that if the cover is till the age of 60, the total cost of buying the plan at the age of 25 or 35 or 45 is roughly the same. A 30-year-old would pay Rs 3.18 lakh over 30 years for a cover of Rs 1 crore. If he waits for 15 years and buys at 45, his total premium outgo would be Rs 3.39 lakh (see graphic). While you pay the same price, your insurance term will be lesser. More importantly, a person who buys late is taking a a big risk till he gets protection. If he develops a medical condition later in life, he may have to shell out a significantly higher premium. If the problem is severe, he may be denied the cover altogether.
Keep a few things in mind when you go shopping for a term plan. First, the insurance cover should be big enough to generate a monthly income for your family, cover major expenses, and settle outstanding loans. Understanding this need, Delhi-based Pradeep Khullar (see picture) bought a term cover of Rs 1.25 crore last year.
Secondly, the policy should cover you at least till the age of 60. Don't take a short-term cover of 10-15 years, which ends when you are in your 40s. You need insurance most at this stage of life and a fresh policy will cost you a bomb. Lastly, don't try to lower the premium by mis-stating facts in the form. If you smoke, drink or suffer from a medical condition, don't hide it. It may bump up the premium by a few hundred rupees, but your nominee's claim won't be rejected because of mis-statement of facts.
2) Take adequate health insurance
Health insurance is also cheap when you are young and costlier when you are old. More importantly, the rule about pre-existing diseases makes a compelling case for buying a cover early. When you are young and in fine fettle, the 3-4 year waiting period is a breeze. Delay buying the policy and you may get afflicted by medical conditions that usually crop up in the late 30s and 40s.
Don't harbour the misconception that your employer's group health plan will be sufficient. While these are useful, they do not provide adequate coverage. Besides, if you lose your job or switch to another company, you may be rendered uninsured for a certain period.
A basic indemnity plan, which reimburses hospitalisation expenses, should be your first health insurance policy. Self-employed professionals also need to insure themselves against loss of income due to hospitalisation. They can supplement the base cover with a fixed benefit policy, which pays them a certain amount for the period that they are out of action.
The cover can be enhanced by taking riders or policies to cover critical illnesses and surgical procedures. However, these should be seen as additions to, and not replacements for, the basic indemnity plan.
3) Open a PPF account for retirement savings
A recent survey by Max Life-Nielsen shows that Indians start saving for retirement only after 40. However, Noida-based school teacher Maria Amin has got herself a headstart because she opened a PPF account last year. The PPF is the most tax-efficient debt option in the market today. The investment gets you tax deduction under Section 80C. The interest it earns every year is tax-free, and so are the withdrawals. It has a 15-year lock-in period, which makes it an ideal tool for long-term goals such as retirement. You can invest a maximum Rs 1 lakh in a financial year. There is also a minimum investment of at least Rs 500 in a year.
This all-time favourite of Indian investors has undergone changes in recent years. One, the interest is no longer fixed and is linked to the bond yield in the secondary market. The rate doesn't change on a day-today basis, but is announced every year in April, based on the average bond yield in the previous year. The 10-year bond yield had fallen to nearly 7% earlier this year, but the recent RBI action to buoy the rupee has pushed it back to above 8%. Consequently, the PPF rate, which is 8.7% for the current financial year, could recede next year.
Another big change is that agents will no longer get a commission for opening a PPF account. So, the investors will have to do the paperwork themselves. The good news is that some banks, such as ICICI Bank and SBI, allow online investments in the PPF.
4) Automate investments and go online
One of the most common excuses for not investing is, "I don't have the time." Days become weeks and weeks turn into months. Get past this stumbling block by automating your investments. For instance, you could start an SIP in a mutual fund and give an ECS mandate to your bank. On a designated day of the month, the money will be invested automatically.
Saving time and effort is just one of the many benefits of automating your investments. It also takes emotions out of investing and enforces a discipline an investor may lack. If the money has been earmarked for investment and is debited from your account, you will not use it for any other purpose. "We recommend that investors opt for SIPs at the start of the month. This induces the much needed financial discipline," says Nitin Vyakaranam, CEO of Hyderabad-based financial planning firm, Arthayantra.
Another smart move is to sign up with 4-5 mutual fund houses for the online investment facility. You might have to visit the branch office for submitting the application form, along with other documents, but the onetime effort will make fund investing easy forever.
The online route has become a compelling option after the launch of direct plans of mutual funds in January 2013. Sold directly to the investor, these plans have lower charges because there is no intermediary. Corporate investors and high net worth individuals are flocking to these plans because lower charges translate into higher returns. According to a study, the direct plans of all categories have outperformed the regular plans in the past three months (see graphic). This gap will keep growing. Invest directly and gain from it.
5) Monitor finances with an expense tracker
You have factored in the car EMI, the house rent and the grocery bill in your monthly budget, but have you kept tabs on the itsy-bitsy expenses, such as casual shopping for clothes, eating out, gifting, and entertainment? Most of the time, these smaller expenses go unnoticed even though they take up a large portion of the monthly budget.
Studies reveal that discretionary spending can be as high as 18-20% of the income for young people. That's quite a large chunk and could impinge on other, more crucial, long-term goals. A 2011 study by Assocham revealed that almost 35% of the urban youth spend up to Rs 5,000 a month on clothing alone. Interestingly, nearly 60% of the respondents felt their closets were full of clothes they don't wear.
To plug the leaks, sign up with a money management portal, such as Perfios (Perfios.com), Arthos (Arthayantra.com) and My Universe (Myuniverse.co.in). These websites aggregate all your finances, from savings bank accounts and credit cards to loan payments and mutual fund SIPs. They help you keep track of your money, alerting you when a payment is due or when you have overspent under a certain head. Suppose you have set a limit of Rs 4,000 a month for eating out. Your money tracker will send an alert when you exhaust 80% of the limit.
6) Set up a contingency fund
It's always good to be prepared for an emergency. This is why financial planners insist that you stash away some money that can be accessed at short notice. The contingency fund will come in handy if you are faced with unforeseen expenses, such as a medical emergency or losing your job. The size of this fund depends on your financial situation. Ordinarily, financial planners suggest that their clients put away at least 3-6 months' living expenses for this purpose. However, if your job is secure and you have enough savings, you can make do with even 1-2 months' expenses.
The money need not idle in a savings bank account, earning a piffling 4%. Instead, you can put it in a liquid fund or a short-term debt fund. Check if the fund levies an exit load when the money is withdrawn within 6-12 months. There are also flexi deposit accounts in banks, where any sum above a specified limit flows into a fixed deposit to earn higher interest. Your money will earn the interest applicable to fixed deposits and will be available to you whenever you need it.
7) Start saving for goals in advance
If the rise in prices of food items is bothering you, here's an even more disturbing statistic. Education costs tend to rise twice as fast as wholesale inflation. Assocham conducted a survey of 2,000 families across 15 cities in India and found that the annual school education cost had risen from Rs 35,000 in 2006 to Rs 94,000 in 2011. Higher education costs are increasing even faster. Five years from now, the tuition fee for an engineering course, currently pegged at roughly Rs 7 lakh, would be close to Rs 12 lakh. In 10 years' time, it's likely to cost around Rs 22 lakh.
The only way to beat this jump is to start saving for your child's education early. A growing number of parents is doing that. An ET Wealth survey in 2011 found that roughly 63% of parents started saving for their children's education before the child turned 3. Another 9% started even before the kid was born. That's good news, because the earlier you start, the more the time available for your investments to grow.
While saving for your child's future needs, make sure that you have taken adequate life cover. While a term plan is essential, you could also consider child plans from insurance companies. Unlike other insurance policies, a child plan does not end if the parent dies. After giving the death benefit in lump sum, the plan waives the future premiums and gives out the amount to the beneficiary on maturity. However, this dual benefit comes at a price: the mortality charges of child plans are higher than normal plans.
8) Seek help of experts
Can you trust your financial adviser? It is very important to have a trustworthy source of objective advice. So, get a professional to make a financial plan for you. Objective financial advice isn't free, but works out cheaper than the ‘free' advice doled out by bank executives and so-called wealth managers of brokerage houses. If you buy a costly insurance plan that you don't need or a mutual fund that does badly, you will lose much more than the annual fee of a financial planner.
How can you differentiate between an adviser and a salesman? The former will try to understand your needs and suggest a strategy to achieve the goals after assessing your risk appetite and saving potential. The process may take days, even weeks. A salesman will leapfrog to the last stage and quickly offer you an insurance policy.
Stay clear of such people who are out to sell you anything that will earn them an attractive commission. Instead, a better option is to go through financial newspapers such as ET Wealth, which can offer unbiased and relevant advice on financial matters since the endeavour is to empower readers and let them take their own decisions.