When you are young and land your first job, savings and investments look distant and even unnecessary. Today, there are so many spending options for young people that it’s easy to live paycheck by paycheck every month and forget about the future. But we all need to plan for the future and create a nest egg for potential emergencies and to fund big ticket purchases like a car or a house. You may also need to save for special occasions like weddings or foreign travel.
Financial planning for the future is even more important in the current environment where there is little or no job security and salary hikes are not keeping pace with the rising cost of living.
But setting aside a small portion of your income every month can create a large corpus over a period of time. Here are five money saving tips for youngsters that can help them get started on the path to financial security.
1. Make a budget. There is an old saying that one must stretch legs according to the length of the blanket. Most often young people get into financial difficulties because they end up spending more than their monthly income or cash flows. This creates a vicious cycle of higher spending especially if you pay through credit card. The best way to avoid this trap is to create a monthly budget of all your expenses. This way you will know where your money is going each month and allocate funds to savings, utility bills and entertainment. Having a sheet with all the expenses will also give you saving ideas.
If it’s higher you won’t have enough for discretionary expenses like entertainment or fashion and certainly not enough to save for future. There are now dozens of apps and online tools that extract the data from your phone messages and emails and create a monthly expense and income chart for you.
2. Don’t wait to save and invest. The most powerful tool in the saving and investment world is the power of compounding. And compounding works best when you start saving early. Use your budget to see how much money you can put into your savings account each month. An annual savings of Rs 10,000 invested in an instrument that gives 10 percent returns on interest will grow to around Rs 1.6 lakh at the end of 10 years. But if you save for 20 years, the corpus will grow to nearly Rs 4.5 lakh.
You can start by opening a recurring account in your bank or post office. You can also start a systematic investment plan (SIP) with a mutual fund of your choice. The other option is to open a public provident fund account in a bank where money will be locked for 15 years but you will get a tax benefit and far higher interest rate than regular banks RDs or FDs. New Pension Plan or NPS is another option to save for the long-term. You can start through bank RDs and include other options over a period of time.
3. Save at least one-third of your income. According to financial planners, you must aim to save at least one-third of your income. This can be reduced to 20 per cent if you work for a company or an organisation that offers employee provident fund (EPF). If you save a third of your income by putting it in an EPF or a bank account or mutual fund, the resulting corpus will make it easier to survive financial difficulties in the job market, to meet big ticket expenses or surprise expenses such as medical emergencies. If nothing, it will help you buy a fancy home later in life or even retire early to pursue your passion.
4. Create an emergency fund. One way to take care of future financial shocks is to create an emergency fund. Set aside a small part of your monthly savings budget and invest it in a separate bank RD or a high interest earning corporate deposit or fixed income mutual funds. You can also invest in high dividend yielding equities or similar mutual funds.
As a general rule, an emergency fund should be enough to fund six months’ of your living expenses including rents and utility bills. Ambitious people can aim to cover their entire six-month income.
5. Pay off your debt. While saving money in a bank account or mutual fund is a good way to plan for your future, repaying your existing debt such as credit card dues or education loans should be the first priority. This is because most often the interest on your debt will be far higher than the interest that you will earn on your savings. So use savings to prepay your debt and then you can think of savings and investment for the long-term.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).