How to start your financial life

After reading my previous posts you are saying “OK! I agree. Let me get my investment stuff started now. How do I begin?” Alrighty then.

For this article, I am assuming that you are in your early 20s and just completed your college education, got a decent job and started earning a good salary. Even if you were working for a few years and haven’t invested much in anything, you can use the information here and have more money when you retire than what you expected to have before.

Let me list out the things we will be doing, in the order of importance. Don’t worry if some terms are not clear, I will explain each step in detail in separate articles in the future.

The best thing about this investment strategy I am suggesting is that its all set to automatic and you will have to spend less than a few hours every month to just check that things are working as planned.

Spend your first month’s salary buying everything you wished for during college

If you were employed for a few years already, then you would have already done this step (many times I think). You can skip to the next section.

Yeah, you read it right. Spending money is good, especially now that you got your first paycheck you can buy everything you wished for. While you were studying, you would have wished to get the latest mobile in the market but were stuck using some old model (I got myself a nice mobile with my first salary). Or you might want to get some new dress for your mom, a watch for your dad. The first salary you get is emotional for most Indians and they would want to spend it for their parents first. Good, that is great to hear. And your friends would ask for a treat as you got a good job and you might like to party.

Do it all, use your first month’s salary for all these things you wanted. If you want, take the second month’s salary too, because once you have started to save money for your future, it would not be easy to stop these investments and its not advisable too.

Repay your education loan

Most of the middle class Indian kids get an education loan from a bank for their college education. And their loan repayment begins as soon as they come out of college. It is very important you repay the loan regularly without any breaks.

If you were working for a while and got any other loans (personal/car/home) make sure you repay them regularly. If you find it hard to repay your loan, discuss with your bank and negotiate the terms. You can even ask to increase the repayment period and end up paying less money per month.

There are various reasons for regular repayment like improving your credit score to making sure you don’t lose money because of late payment penalty. Remember the “compounding effect”? It works for debt too. It increases your debt exponentially if you don’t start paying it now. So it doesn’t matter if you invest your money now, paying off all your debt as quickly as you can is more important.

Get an Insurance

Life Insurance is very important and I would say mandatory if you have someone depending on you for their expenses. It could be your parents, your younger siblings still in school, your spouse, your children. If they can’t earn money on their own, they are a dependant. You need to protect them in case you die and they don’t have any other source of income.

In most offices there would be some employee who is also an LIC agent and would try to sell you a life insurance policy. They would use some terms that you won’t understand like endowment policy, moneyback policy, etc.

My advice regarding those: Stay Away from them. Run, like your life depends on it. The reason is traditional policies that they suggest is as good as throwing away part of your money into the fire. In fact when your policy expires (somewhere in your 40s) or when you die before the policy expires you/your dependants would be getting a very low sum assured that would be good enough for just a few months of expenses. The money you put in these traditional policies don’t grow with inflation, so the value of your money erodes every year. And your dependants would be financially stuck when you are no longer with them paying the bills.

In future articles, we will look at a better way of insuring yourself (and also why you really need insurance) using something called Term Insurance. This is so much cheaper than traditional insurance plans, which means you have extra money remaining which can be put in investment products which return better interest rates which can actually beat inflation.

Apart from life insurance, you would also need to take health insurance which will pay your hospital bills when you get sick. Most companies make it as part of the package, but if you are working for a very early stage startup which doesn’t have these perks, you need to take one. Remember you need to take health insurance for your dependants too and there are various different types of policies that would help.

Investing for your retirement

This is the part where you invest your money for the long term so that it grows to a huge amount that you can live without any problem after your regular income stops. Till now we have only repaid our debt, insured ourselves against death. We will look at various investment products and strategies which will earn you a nice extra money in the long run. There are various safe products like PPF, Fixed Deposits, etc., and riskier products like putting your money in the equity market which does provide higher returns. Most companies which has more than 20 employees already invest a small amount in the Employees Provident Fund which is a great investment.

There are other classes of investments like Bonds, buying Gold, buying land/house, etc. Each has its own levels of risk and reward. And some classes of investment follow a cycle of highs and lows which need to be understood before you invest into them. Remember every form of investment is risky, only there are various levels of risk. The more riskier an investment is, the higher the reward. The less riskier the investment is, lower the reward.

If you need to beat inflation, you need to take a little bit of risk. And how to protect yourself against the risk? By investing in low risk products too. So your overall portfolio risk decreases. This is called portfolio diversification and will help protect your money when there are sudden falls in the equity market like in 2009 or the recent drop in gold prices. When others are worrying about their hard earned money lost, you will be sitting comfortably with your money growing and earning you a handsome return.

Saving for short term goals

Everyone has short term goals like buying a nice bike/car, going for vacations to some exotic places, buying a nice camera, the latest game consoles, etc. These are important to have as it will greatly improve your lifestyle and also help remain sane after working more than 9 hours in a cubicle. The 10 day trip you take to some foreign country will help you to meet new people and open up your mind. You should go out often and live your life too.

You need to set up separate accounts for such short term goals and put in a small piece of your money in it every month. If you intend to go out of country every year, just calculate the entire cost of the trip, divide it by 12 and put in that amount in a separate account every month. End of the year you will be sitting on a nice pile of money that you can use to pay for your trip (or the latest gadgets/car). And these accounts also return a nice interest rate so you get slightly more than what you put in for the whole year.

If I keep investing my money, when do I get to spend it?

Ah, right. We have at last got to the part – spending your money. You may be wondering why I talk about it at the last. Because, the right way to handle your finance is to invest your money first and then spend the rest.

You may complain that you have to have your house rent, daily expenses, food, travel, etc. I know they are essential and the best part is most of these expenses are predictable. You know how much your house rent is, how much you spend on your groceries, travel, eating out, etc. Remember that was the first exercise we did two days back.

Now is the time to take a look at that sheet of paper. Lets say you earn Rs.25,000 per month and your monthly expenses are about Rs.20,000, then your remaining Rs.5,000 is a surplus that can now be invested. So we will make sure we have a system setup which will take away this Rs.5000 at the beginning of the month automatically. I prefer within 3-5 days of your salary being credited. If you get your salary on the last day of every month, set up all automatic account transfers to various accounts on the 3rd to 5th of the month. It could be your loan repayment EMI, transfer to PPF, any deposits you make, etc.

If your money automatically goes to the different investment accounts, you don’t see it and you wouldn’t miss that money. So it forces you to spend only the remaining money and automatically have a tighter control over your budget, while your investments grows without you lifting a finger.

If you noticed, I didn’t mention anything about cutting down your expenses – yet. You can maintain the similar lifestyle you have today and also invest for your future. It isn’t that hard. Of course, if you are having lot of debt like credit card and personal loans, we will have to make some adjustments to your lifestyle a bit, but soon within a few years you will be debt free and can save more.

Planning your financial life isn’t that hard and everyone should begin investing as early as possible. With the online banking and automated transfers, it has become very easy to invest today than it was a few years back.

Now after reading this big essay, you would want to know more details about the various investments products and in which you should put your money in. We will discuss all these in details in future posts one by one.

So tomorrow, you will learn about repaying your loans and why you should repay them. We will also see what your credit score is, how your previous loans affect the score and how the score will affect your future loans.