I usually start Money Management and Financial Planning sessions by mentioning the richest individuals in the world and India. Names are rattled out quickly. The next question is that if these people have built their fortune by working 16 hours a day, or accumulating funds in their bank accounts. The quick answer is No, but I never fail to notice a shadow of disappointment on young faces. The underlying unspoken thought is about their perceived inability to reach there.
The first challenge a beginner faces is to put aside funds to multiply. Many of them have just moved out of parental homes, to a new base. The cost of accommodation, transport, internet and healthy food are prime concerns. Yet, a self-assessment exercise reveals that they can save a certain predetermined percentage of their income by economising and cutting entertainment costs. This habit of putting aside a certain percentage becomes a sound investment strategy for financial wellness.
Pay Yourself First is a rule several financial planning experts recommend. The recommended percentage is ten percent of your net take-home income – higher for those who can afford it.
Warren Buffet famously said that the eighth wonder of the world is the power of compounding. Compounding basically means earning interest on interest. Ploughing profits back in a business or any sound investment can give exponential returns.
The following chart shows how an investment of Re.1/- can become Rs. 3.35 crores in 25 years, by merely doubling the number every year. The sooner one starts, the better.
One needs to secure life, health and assets with insurance to prevent sudden outflow of funds in an emergency. Money can grow only if soil is fertile, and the base strong.
The capacity and appetite for risk varies as per age, career profile, family responsibilities and temperament.
The investible assets need to be again divided into high risk, medium risk and low risk assets as per the risk profile of the individual.
Bank deposits and debt funds fall in the safe investment category. Gold and real estate go through their cycles, and an assessment for the next 5-10 years need to be taken before investing money. Stock market investments carry a high risk. If one has not studied the subject, and chosen an investment strategy to be followed, it is safer to invest in mutual funds and leave your money in the hands of market experts. Returns will look good or bad, depending on the time frame chosen.
A beginner needs loans – to buy a house, vehicle or maybe to take care of some other short-term requirement. Longer the term of the loan, higher the interest to be paid.
If a person avails of a loan of Rs.25 lakhs to buy a house today at the rate of 10 per cent per annum, s/he will pay an equal amount of interest in 10 years. If the pre-EMI interest is included, the cost of the house is more than Rs.50 lakhs in the long run. Market appreciation of the property varies for different locations, and one needs to do the cost-benefit analysis carefully. Rentals are an expense, but work well if the employer bears the cost in some manner.
Credit card debt needs to be managed carefully, as credit card issuers charge the highest interest in the banking industry at more than forty per cent per annum, if the debt is not paid on the due date. Credit cards are an asset, as long as you pay the bills on the due date. It is the easiest trap to fall into, with its ease of credit, to the extent of sanctioned limit.
A bad CIBIL score can block one’s chances to get a fresh loan, or find another job. It is the financial parameter that matters most for a young person. There are other platforms like Public Credit Registry (PCR) being introduced, and one needs to understand the complete impact of debt on future spending.
Uncertainty is the name of the game in the current scenario. Other than government jobs, no other career guarantees life time employment, profitability or engagement. Job profiles are disappearing fast with the advent of digitalisation and artificial intelligence. Organisations follow hire-and-fire policies to manage their own profitability.
One needs to develop more than one passive source of income to cover the risk of an income being discontinued. It can hit harder, if one has dependents to care for. Passive income can be lease rentals, interest, dividends on shares, methods of earning money online, affiliate marketing, part-time jobs or moonlighting (freelancing). There are several scamsters around to fleece people with promises of high returns, so one needs to proceed with caution. Having a partner that earns helps. It ensures financial security, in case, the career of one partner hits a low for some reason.
It makes sense to hire a fee-only financial planner. Those who sell products recommend products which will fetch them good returns, and not the ones that suit you best. An online search will show you several examples of mis-selling, and the investors fighting long battles to claim compensation for losses suffered.
A Certified financial planner is like a family doctor, or personal beautician who knows the personal history of the client, and dispenses appropriate advice. Engaging the services of a CFP makes more sense than buying financial products on random advice from different sellers. Online financial planning services are also available, but take care to choose between personalised advice and algorithm-generated financial reports.
Broadly, financial planning for a beginner can be summarised as follows: