Money mantras for the under-30 :: Business Line

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Party and be merry — but do put away money for the future. Being smart with your wealth when you are young will help you breeze through life

You never had it this good! You are young, earn well and the world is your oyster. Make the most of this glorious period. At the same time, play your cards right so that the fun continues long into the years. Here are some financial tips to help you make the buck go far.

A rupee saved is a rupee earned. Start small if need be, but start savings soon. Rather than a fixed amount, save a certain portion, say, 25 per cent of your earnings every month. This way, as your income grows over time, you save more in absolute terms. Also, with time, increase the savings rate. The idea is to save as much as you can. Set aside the planned savings at the beginning of the month itself. In finance lingo, you are ‘paying yourself’ first.

Get a head-start

Importantly, don’t let these savings idle away in your bank account for a piddly 4-6 per cent annual return, that too taxable. Deploy your funds smartly. Time is indeed money. With 30 to 40 working years ahead of you, time is the biggest factor in your favour. The importance of starting off early on your investments cannot be overemphasised; the wonder called compounding is a force-multiplier. Here’s an example. Start saving ₹2,000 each month when you are 25 and continue until you retire at 60; at 12 per cent annual return, you will accumulate nearly ₹1.3 crore. Delay the start of the savings by a decade to the age of 35, and at 60, you would have accumulated just about ₹38 lakh. Yes, that’s nearly ₹91 lakh less. Ergo: Start with your investments right away.

Make bold with equity

Fortune favours the brave. Being young, your risk-taking ability should ideally be high. You have years to recover from temporary setbacks and may have fewer family responsibilities. But you may still be risk-averse, putting money only in ‘safe’ debt instruments, such as bank fixed deposits and shunning ‘risky’ equities.

That’s not a good idea. Unless you take calculated risks, building significant wealth can be tough. Debt investments are essential, no doubt, but many of them don't beat inflation in the long run. Equity generally does. So, if you have inhibitions towards equity investing, reduce them.

So, should you avoid debt and plunge head-long into equities? No. Rather, it’s important to hit the sweet spot on your asset allocation — the distribution of your investments across asset classes, such as equity, debt, real estate and gold. Your asset allocation should be tailored to your age, risk profile and specific circumstances.

A popular back-of-the-envelope calculation is that the equity percentage in your portfolio should be 100 less your age. So, if you are 25 years old, the equity exposure should be about 75 per cent. But this is just a thumb rule; use it in combination with other factors relevant to you. For instance, if you are shouldering a lot of family responsibilities already and cannot afford risking money, equity investing in a big way may not be a good idea just yet. Ditto if you plan to pursue higher education for which you will need the money soon. Go for equity when you can withstand short-term ups and downs, and hold on long term to reap the benefits. That said, it is a bad idea to postpone equity investing indefinitely for non-essential expenses that can be deferred.

Also, remember, you are investing long term and not trading in equities. The latter (short-term buying and selling) is suitable only for those with a very high risk appetite and adept at it.

SIP all the way

Equity investing can be complicated, and investments which go sour often scare away young investors for good. The companies you buy equity in should be well-run with good prospects, and the stock should be bought at cheap valuations. But what if you don’t have the time, inclination or knowledge to make the decisions?

Going the mutual fund route is a good option. Even those who understand equity investing should consider investing through mutual funds. Here’s why. At mutual funds, investment professionals evaluate, pick and churn stocks — it’s their full-time job.

Besides, mutual funds invest across stocks; this reduces the risk from a few of them turning duds. Well-run equity funds have delivered stellar annual returns in excess of 20 per cent over the long term. Not all mutual funds are equally good. Go for a fund that has beaten its benchmark consistently and is among the best in its category. Frame long-term goals and use mutual fund investments effectively to meet them.

When you start out, invest in large-cap, diversified equity mutual funds and balanced funds — these are less risky. Gradually, expand the horizon to include riskier mid and multi-cap funds. You can also save tax by investing in equity-linked savings schemes (ELSS) which have a lock-in period of three years.

Invest in mutual funds through the systematic investment plan (SIP) route rather than lumpsum. SIPs inculcate a disciplined, regular investing habit. By investing through market ups and downs, a SIP can reduce your average cost of purchase. Don’t stop the SIP when the market is going through a rough patch. SIPs work great in the long run precisely because equity investing is a roller-coaster ride. You get more units of the mutual fund in a falling market, making it the best time to invest.

Bet on debt and gold too

Equity and the young may be made for each other. But don’t ignore debt investments. They lend safety and regular incomes to the portfolio. To start with, 20-25 per cent of your portfolio can be put in debt and the allocation increased as you age.

Ideally, go for debt investments that cumulate returns. The public provident fund (PPF) is among the best options. It is a long-term investment (15-year extendable in blocks of five years), gets you a tax break, and there is no tax on both the interest accrued (8.7 per cent currently) and the maturity amount. Similarly, your contribution to the employee provident fund (EPF) gets you compounded tax-efficient returns (current rate is 8.75 per cent). When you shift jobs, transfer your EPF balance to the new employer. Use it to build your long-term corpus.

If you seek regular income though, invest in long-term (five years and above) tax-saving fixed deposits with banks and the post office. The interest rate on these deposits is around 8.5-9 per cent currently. These give you a tax break on investment, but the regular interest paid is taxable.

Gold can be a good risk diversifier. But don’t invest more than 10 per cent of your portfolio in the yellow metal. Go for gold ETFs — they are cheaper and convenient.

Think through real estate

For many of us, buying a house is a cherished dream. But don’t jump in. Think through what will perhaps be the biggest monetary commitment in your lifetime. If you have plans of higher education, don’t make the mistake of buying a house on loan. You will not have cash flows while studying. But the loan’s equated monthly instalment (EMI) has to paid; else you lose the property.

Make the commitment only when you have settled in your career and are confident about servicing the loan. Also, remember that the house you buy to live in is not an investment, since you won’t sell or rent it out. Heavy outflow towards the loan servicing can leave you with little to invest in equity, debt or gold. So, assess whether you may be better off living in a rented house till your income levels are sufficient to service the home loan and also continue with other investments.

Investing in a house, as against buying to live in it, also needs to be thought through. Yes, you can expect capital appreciation on the house, rental income and tax breaks on the loan servicing. But a chunk of your income will go towards repaying the loan. Check whether you will still have enough for your other investments.

Cover yourself

“Insurance! Why? I am young and healthy, nothing will happen to me” — that’s how most youngsters respond when advised to buy life and health insurance. But it makes sense to get yourself insured. Life and health are unpredictable, and the wise don’t harbour illusions of invincibility. A big-ticket health-related expense can leave your finances reeling. Also, if your family depends on you, your absence could leave them financially stranded. It’s better to be safe than sorry. Besides, when you start young and healthy, the premium cost will be very economical. You will also likely breeze through the initial years when there may be policy exclusions. Don’t just depend on the cover provided by your employer. It may be insufficient and you won't have an umbrella if you stop working or are in between jobs.

The thumb-rule is to get your life covered for at least 10 times your annual income. So, if you are earning ₹10 lakh a year, get a life cover of ₹1 crore. Also, get health cover of ₹4-5 lakh to start with and increase it gradually.

Keep it simple when it comes to insurance products. Go for term insurance plans which offer significant cover at low premiums. Also, buy these plans online since they cost much less. Go for insurers with a high settlement ratio. And if you have a home loan, make sure the insurance cover is sufficient to meet that liability too.

Don’t mix insurance and investment. Insurance should cover your risk while investments should secure your financial future. So, stay away from ULIPs and traditional insurance policies which are not cost-efficient and may not deliver on returns. Instead, a combination of term insurance and well-run equity mutual funds will cover you adequately and also deliver healthy returns.

Cut the tax

It’s always the after-tax return that matters. Check what you will get in hand after giving the government its due. Hold on to stocks and equity mutual funds for at least a year, since there is no tax on gains after this period. Debt mutual funds suffer tax on gains but less if held for at least three years.

Make use of Section 80C instruments — investments up to ₹1.5 lakh a year are eligible for tax breaks. So, you can save ₹15,450 in taxes if you are in the 10 per cent tax slab, ₹30,900 in the 20 per cent slab, and ₹46,350 in the 30 per cent bracket. The Section 80C basket includes ELSS mutual funds, PPF, EPF, long-term bank and post office deposits, life insurance and ULIP premiums, pension plans, home loan principal repayments and contributions towards the National Pension Scheme (NPS). Besides, contribution to the NPS up to an additional ₹50,000 gets a tax break – that means a further tax saving of ₹5,150 – ₹15,450 depending on your tax slab. In addition to Section 80C instruments, you get tax breaks up to specified limits on donations to approved institutions, health insurance premiums, and interest payments on education loans and home loans. 

But don’t invest or incur expenditure just to save tax. A combination of ELSS schemes, PPF, term insurance and health insurance will help you build a well-rounded portfolio and cover risks, the primary objective. The tax savings will be a sweetener. Invest early in the year or through the year rather than wait till the eleventh hour in February or March. This will help you make well-informed choices and improve returns.

Declare to your employer the eligible investments made and expenses incurred. Some employers adjust the monthly tax calculation only after receiving both the declaration and documentary proof. If you have forgotten to declare the investments and expenses to your employer, you can still do so when filing your income tax return for the year.

Prep for the golden years

It may seem too soon to salt away money for retirement but it is never too early to start. Compounding will reward you handsomely. Complement your equity mutual funds and PPF with NPS contribution — one of the most cost-effective ways to get regular pension in your golden years. Depending on your risk appetite, you can alter your NPS allocation between debt and equity. For youngsters, it makes sense to allocate the maximum 50 per cent towards equity and the rest to debt — this can be continued till you are close to retirement when the debt portion can be increased to reduce risks.