Landing your first job and earning your first pay cheque is exhilarating. The joy and the excitement of the first salary are next only to first love and are etched on our memory forever. But there is also a risk of getting carried away and splurging your newfound riches. This temptation would be high if you have spent years surviving on bare minimum pocket money or allowances from your parents.
While there is no harm in enjoying the finer things in life if you can pay for them, you should not forget the long-term goal. The first pay cheque is not just an event but the start of a new chapter in your life and one that will be the longest.
It will ensure that your post-retirement life becomes as comfortable and fulfilling as your working life.
This requires a proper financial system that should start from your first salary. There are five golden rules to save and invest from the first pay cheque itself.
1. Open an RD or recurring deposit account in your bank. A recurring deposit where you deposit a small amount in the bank every month is a great way to build a corpus without burdening yourself. The interest on RD deposits is the same as that for a fixed deposit with similar tenure. You can start with as low an amount as Rs 500 per month and increase the deposit amount as your salary grows. The monthly deposit in RD may seem small initially but it will grow into a large corpus if you keep doing it year after year.
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The amount saved in the RD will become your emergency fund or means to achieve bigger goals such as buying a car or the margin money for a house.
2. Invest in an exchange-traded equity mutual fund (ETF) or an index fund. Once you have settled into your new career and have built a few months’ worth of salary in your bank RD, it’s time to take some risk and earn a higher return on your savings. The ETFs or index funds are the best way to generate higher interest without taking too much risk. ETFs are passive funds where the fund manager tries to replicate actively traded equity indices such as Sensex or Nifty50 in their portfolio. As such these ETFs closely track the performance of benchmark indexes.
The best thing about these funds is that you don’t take any risk with the quality or skill of the fund manager and the expense ratios are very low. A low expense ratio will translate into higher net returns over the long term.
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3. Buy health insurance. The medical costs are growing in double digits in India and medical emergencies in your family can not only punch a big hole in your finance but could derail your long-term financial goals. The best way to guard against this risk is to buy health insurance as early as you can afford it. It is best to buy health insurance before you cross 30 years of age because premiums are low and you can get big coverage for a small premium. It’s better to buy family floater plans that cover your parents as well.
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4. Buy a term life insurance plan to insure your earnings power. This is an essential component of smart financial planning. The best way to achieve this is to have a plain vanilla term insurance plan. In pure-term plans, the nominee or the dependent family member receives the sum insured in the unfortunate event of the demise of the insured person. This will ensure that your family continues to pay their bills even if you are not there as a breadwinner for the family.
This is not the case with other life insurance plans such as endowment, whole-life plans and unit-linked insurance plans (ULIPs) which have a saving component and thus offer a low sum insured for the given premium.
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5. Take a loan to buy an asset but never to fund consumption or lifestyle. It’s not always possible to buy or fund all our purchases through our own savings. And it’s okay to get a loan to fund big-ticket spending as long as you can service the loan and repay it within the stipulated time.
You can also take a loan to invest in an asset that can generate an income or cash flows such as commercial vehicles or rental housing. But it's poor financial planning to take a loan to fund consumer goods, house furniture, foreign travel or a family wedding. The only exception is buying a car given the costs involved. But as a thumb rule, never go for a car loan with a tenure of more than five years.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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