Financial Planning Strategies For Everyone - I : Young Earners
Financial planning is meant for everyone. It pertains to every decision that impacts our money and financial situations. The kind of money decisions we make would have to differ based on the life stage we are currently at. This is because our financial needs would differ atthese various stages. Therefore, over the next three weeks I am going to cover a few broad financial planning strategies for individuals in different phases of life. And today is dedicated to strategies for young earners aged between 21 and 35.
For young earners who have only recently been exposed to a steady inflow of money, the biggest challenge is to discipline the mind. They must learn to curtail impulsive decisions and exorbitant spending. The overriding thought for most young earners is to enjoy life to the fullest. They think that they have a long time ahead to concern themselves with financial planning. Such thoughts are understandable and justified. But the focus for all young earners should be on cash conservation and saving. They must look to avoid financial mistakes. I have talked about what young earners must not do in an earlier piece, What NOT To Do When Starting Out.
It would be very healthy to have a disciplined practice of saving at least 10% of their monthly income. It would then help young earners to define their major financial goals. After this, the available savings may be invested across multiple asset classes. This must be done in accordance with an asset allocation strategy. Doing this would allow young earners to take full advantage of the fact that they have a number of years ahead of them by allowing them to focus on building a financial foundation for the future.
Today's young earners aspire to own the best of everything life has to offer. Nursing such ambitions may be worthwhile. But funding such purchases through excessive debt and EMI payments is not. Young earners must ensure that their EMI payments don't exceed 30% of their take home income. Making all their purchases completely in cash would be ideal. They must not take on debt solely for tax benefits. Debt must be taken on only when EMI payments do not compromise their financial stability. Otherwise it could see them suffer severe cashflow management problems.
Some young earners may look to get married and start a family during this phase. In such a case, they must assess whether they would like to take a career break on account of these events. And those who take a break must plan for a stoppage in their income. This is even more true in case of starting a family. Any break taken could last for a good few months. Therefore it is important for them to have a robust emergency fund in place to tide over this period. A good way to build one is to keep 9 to 12 months worth of expenses in cash and savings deposits. This would cover them well for the best part of a year after such events.
Ensuring that adequate term and health insurance coverage is in place is also essential. Term insurance must be purchased to the tune of 20 times annual take home income. Getting covered at a young age would also mean that premiums are reasonable. Any additional riders offered with the policy must be avoided. Health insurance coverage must be purchased for a minimum of Rs 10 lakh apart from corporate health cover. Policies with clauses such as Co-Pay, room rent sub limits and long waiting periods for pre existing diseases must be avoided. Unmarried individuals can purchase an individual policy. Those who are part of a family may purchase a family floater policy.
Another major ambition for most young earners is that of wanting to own a home. But the most common mistake made in fulfilling this ambition is taking on exorbitant home loan EMIs. Young earners should look to take on real estate debt only when they have a substantial pool of savings and a stable income to serve as a safety net. The best time to buy a home would be when they can pay at least 50% of the value of the property as a down payment. This would ensure that EMI payments do not place their monthly income under major stress.
Lastly, young earners must ensure that they don't compromise on building a strong personal balance sheet in pursuit of saving tax. Planning taxes is undoubtedly important. But it should never be the sole objective of our money management endeavours. Tax aspects should be viewed as a part of the larger picture. The focus should instead be on building the right mix of appreciating long term assets. At least 20% of the total asset mix must be allocated to financial assets (market linked investments).
Physical assets such as real estate, vehicles and gold should primarily be restricted to need based purchases.
From the standpoint of financial planning, young earners find themselves in a sweet spot. They gain access to money and possibly some disposable income. They have very few financial responsibilities, if any. They also have a number of years available to them for the achievement of their goals. This means that they have the perfect opportunity to give themselves a head start financially. Young earners should therefore primarily focus on building a strong financial foundation for the future. They must look to avoid financial mistakes at this stage. It represents the perfect time for them to pick up and develop the right financial habits. Taking care these aspects would set them up well for the future.