Make that first investment; waiting is costing you a bomb!

After every lecture on financial planning, I get many requests for information from, young people just starting out in life. Regardless of their age, people do realize that a little upfront planning and action can put them ahead of the game. Therefore, here is what I would call a lesson 101 for you to do something. For those parents who have approached me with “how do I teach my children financial responsibility” kind of questions please pass it on to them!

Let us start at the very beginning…a very good place to start

The first steps have to be A, B, C or Do Re Mi…..if that sounds better!

Set your goals. So what are the steps?

1. Think where you want to be in five years: How much will you have invested? Will you own a home? Where? What size? Will you have kids who will go to college someday? What kind of car do you see yourself driving? Will you take time off from work to study? To have a baby? To pursue a different career? What else is important to you financially?

2. Think about the roadblocks and the potholes along the way – you do not want to fall, do you? Write down your financial worries. Being late on credit card payments, delaying the student loan repayment, borrowing from your parents (anybody), increasing housing EMIs, ..could be endless, so please be truthful. Make a list of your financial worries

Set Your Goals, NOW!

Let us put some numbers and dates in place to see if it helps to explain what I have said. Use this timeline to sketch out what you hope to accomplish year by year:

Saving Goals by Time Horizon

Goals for 2011:
1.
2.

Goals for 2012:
1.
2.

Goals for 2013:
1.
2.

Goals for 2015:
1.
2.

Goals for 2017:
1.
2.

Khyati and John are in their late 20s. She has a MBA in finance and he a doctor. They were married last year. She owes Rs.500, 000 in educational loans. He has just started his practice and has a student loan – Rs. 800,000. She makes Rs.800, 000 a year and he makes Rs.200, 000.

They live in a rented house. John has just started his practice after quitting his job in a big hospital. He wants to buy a clinic before he commits to a house. They think they want to start a family in about four years. They have been using credit cards since their college days and now owe Rs.6, 000 on three cards. Like all 26 year olds, they want a house, a better car, a vacation in Europe, a couple of babies, but they were quick to realize one thing. There is too much of conflict of what they wish to do with their money, and too little money!

Here is how they prioritized their goals over the next five years:

Khyati and John’s Goals
Goals for 2011:
1. Pay off Rs.100, 000 of school loans.
2. Pay off remaining credit card balances and resolve to pay bills in full each month.
3. Start contributing Rs. 50,000 to a unit linked insurance plan.

Goals for 2012:
1. Pay off Rs. 300,000 of student loans. Khyati feels this will be possible because some of her National savings certificates are maturing (worth Rs. 50,000) and her employer is creating a scheme by which she will get a matching grant to pay off an educational loan.
2. John to start a SIP of Rs. 5000 per month to build a “clinic buying corpus” – in 5 years they hope to have enough money to make a down payment.
3. Increase Unit linked plan contributions to Rs. 60,000 – including a Rs. 10k top up.

Goals for 2012:
1. Pay off all educational loans! Now fully debt free.
2. Buy a car. Downsized EMI from Rs. 11,000 to Rs. 4340 p.m.
3. Think about a house and start looking. Alternatively, start looking for buying a clinic.
4. Increase SIP amount to Rs. 15000 per month. Continue the unit linked plan at Rs. 65,000

Goals for 2012:
1. Make a down payment – for a clinic or house, whichever is first!
2. John to accept full responsibility for the mutual fund SIP, unit linked premium, and the car EMIs. Since his income has gone up vertically, he is comfortable doing this.

3. Planning to have a baby!

Goals for 2013:
1. First child is born. Take out term life insurance to cover the clinic mortgage and the child’s education if something should happen to either parent.
3. Have a will drawn up by appointing a friend as a guardian for the baby.
4. Save 500,000 per annum in unit-linked plans, mutual funds, and plan to buy a house.

You can see from this example that if you have competing goals, it may call for a multiyear approach. Try to make some progress on each goal every year. Also Khyati was very happy to have been able to make this plan, postpone their car purchase, shelving the second car, downsize her car EMI, downsizing the “vacation goals” to what could be covered by her LTA, realizing that since theirs was a love marriage and parental support was missing, they had to be far more frugal than some friends. John was happy to have his clinic – he never thought it possible. He was happy to give up his personal expenses to save for a goal. They were happy to be free of debt so soon.

It is your life and you need to make the choices – in this case Jointly.

You can see from the example that in order to meet your financial objectives, you have to have some discretionary cash to put aside. The only way to do that is to take a close look at the money coming in and the money going out. You should also make sure to budget money to invest. Ideally, that will be about 10% of take-home pay. Otherwise, you may need to work up to that goal over a couple years.

Set Aside an Emergency Fund
Your first investment goal should be to set up an emergency fund–money you can tap in case you lose your job or are hit with an emergency bill, such as medical expenses. I cannot emphasize enough how important it is to set aside some emergency cash: It gives you peace of mind, and it gives you a cushion so you do not fall into a vicious cycle with credit card debt. Typically, you will need enough in your emergency fund to cover three to six months’ worth of living expenses. This money should be invested in a money market or savings account.

Start Building Your Core Portfolio

Once you have taken care of the emergency fund, it is time to choose the building blocks for your portfolio. This does not have to be difficult. Index funds–either conventional funds or exchange-traded funds–fit the bill nicely. An index fund buys enough stocks or bonds to mimic the benchmark it covers. An exchange-traded fund is an index fund that trades like a stock. With regular mutual funds, (that is what an index fund is), all movement in and out of the fund happens at the end of a day.

If you are going to be adding to your investments monthly, use a conventional mutual fund Systematic Investment Plan. If you are in your 20s or 30s and are investing money for the long term (you do not plan to touch it for at a long time), you can use an allocation something like this:

• 10% Money market mutual fund (emergency reserves being built up)

• 25% Unit linked life insurance plan – for 40 years and willing to pay premia for longish period of say 30 years plus. This should be in funds with very low asset management charges – sub 1% if possible. It does not matter if the upfront load is high.

· 65% – SIP in a multi-cap mutual fund as an SIP route. This should be in a flexi- cap fund (also called Dynamic asset allocation)

Regardless of which fund or Unit linked plan you use, make sure the expense ratio is low. For example, try not to pay more than 0.9% for a unit-linked plan and 2% in a managed mutual fund. Expenses hurt! Check the costs of a fund!

Summing Up

To start your life with a good financial base, you need to understand your assets and liabilities (net worth), set priorities for your goals, create a realistic spending plan, set up an emergency fund, and put the core pieces of your investment plan in place.

If you have been academically successful, socially successful, you surely can be financially successful. To start, you need not be successful, but to be successful you need to start!