Financial Planning for Young Adults – Myth and Reality

Financial Planning for young adults
Knowing how to manage money is important for everyone irrespective of one’s profession, financial situation, geography, lifestyle, etc. Even if you are a billionaire you still need to plan and mange your assets to preserve their value or to utilize them optimally and have a succession plan to pass on the baton to the next generation.

If you are poor or in the lower middle class its highly essential for you to plan your finances in addition to other responsibilities like education, career, etc to get ahead in life.

Young Adults’ Myth about Financial Planning

Most young adults, who start off in their career and become financially independent from their parents have certain myths about managing money. Since most of them (barring exceptions) have been growing with their parents’ support and may not have the experience using or spending their own money they feel too excited and try to go overboard on a lot of things. Lets look at a few myths and the reality to understand the cause for financial problems that youth face.

Myth

I don’t have any dependants so I have the full liberty to use money according to my wish.

Reality & Suggestion

Probably there are no dependants because your parents are currently earning but you may also have to keep in mind that they might retire at some point. This is one probable responsibility. The other long term potential responsibility is the time you get married where you have to take care of your spouse, and later probably kids. For this you need to plan and start saving today rather than waiting till the 11th hour.

Myth

No dependants as such so I don’t need life insurance.

Reality & Suggestion

Young people think they don’t need life insurance, but they need to take a closer look at their family and personal situation. Remember that if you are not there tomorrow, your family is losing you as well as your income and financial support (however high/low your income is). So you still need life insurance to compensate for the possible loss of income.

Even if you think you don’t require it you should have a term insurance, which will definitely prove useful in case of major life changes like your parents being dependant on you or your marriage, marriage/wedding expenses for your siblings, etc. In some cases where you are supporting education of siblings or financially supporting them, it becomes even more critical to have life insurance cover.

Myth

I would enjoy life for a few more years and then plan. Anyway I have some savings for emergencies

Realty & Suggestion

You can definitely have a good time travelling, partying, eating-out, etc. But remember that an emergency fund is only for contingencies. The real ‘investments’ are what you invest for future needs in stocks, FDs, gold, real estate, etc. These are assets that will appreciate in value over time and in some cases generate regular income (interest, dividend, rent, etc.)

These cannot be created overnight so start now. However, try to save atleast 20% of your take home pay every month, which can be channeled in to investments for future needs. Remember that an early bird has a higher probability of success.

Also as an early mover you have more time to learn, experiment and build your portfolio – Rome was not built in a day….and the same holds true for your investment planning.

Myth

I’m well qualified so I know how to save and life prudently within my means. I don’t want to gamble in stock, gold, etc.

Realty & Suggestion

You have made a good start but just budgeting and saving will take you a little far. You need to invest in assets that will appreciate in value or provide income flows in future. These assets could be stocks, gold or even real estate or other assets as per your choice or comfort level.

Investing is not ‘gambling’ but it is still risky because you are taking some calculated risk. There are some people who trade known as ‘speculators’, who are qualified and experienced in that line of business (but this is called ‘speculation’ not ‘gambling’).

Myth

Once I get a promotion or a lumpsum amount or a lottery I will start and plan seriously

Reality & Suggestion

If you wait for a few days or weeks for an auspicious time (for reasons relating to astrology, spiritual, etc) I understand your sentiment. But if you just have an excuse to procrastinate the chances of success are minimal. Start saving and investing regular however small the amount of sum may be. Even a systematic investment plan of Rs.3000 every month can go a long way in building a good corpus.

Myth

I don’t have to think about marriage, kids, etc. Once it comes closer to my radar I will plan

Reality & Suggestion

Even if you have not though about it personally, you have to make a financial provision for this. No harm in planning or allocating in advance.

Remember that today many would-be parents are booking school admission even before the child is born. Why? Because getting admission in good schools is highly competitive and expensive. Education costs are growing at 20-25% every year which means….in the next five years the fee would have doubled….and in the next decade it would have quadrupled.

Its not about just about education – everything right from your daily cup of coffee to price of petrol is increasing and inflation is eating in to your returns and money value. So Rs.1 lakh, which used to be a princely sum in 70’s and 80’s is not a big deal today as it can last for 3-4 months only for a middle class family.

So planning in advance and saving and investing in assets that will grow in value and provide income is critical. Even if your plans (say marriage) get postponed or cancelled atleast you don’t have to worry about the monetary part. Its not just about money ….its also about having property, insurance (for major contingencies), resources for pursuing hobbies or things that you are passionate about.

Myth

I wont retire (or) I have my own property and some savings so retirement planning, investing, etc are already taken care.

Reality & Suggestion

Probably you are lucky to have your own house and some savings to start with. But this along will not suffice for your retirement. You need to have a steady income to take care of your daily needs after retirement. The savings that you have today (lets say Rs.20 lakhs) may last for 4 years of expenses (keeping current cost of living in mind).

But in future the cost of living may shoot up drastically. If cost of living doubles the same amount may only last for 2 years. So always try to have more investments or savings to be on the safer side keeping in mind the future value of money. As discussed earlier a pack of milk (500 ml) costing Rs.12 today may double to Rs.24.

These expenses cannot be curtailed because they are absolute necessities. However, if you invest in some income generating assets like equity, gold, real estate, etc you will have some cash flows to compensate for inflation. If you prudently manage to curtail expenses and increase incomes you can generate positive cash flows after retirement to.

Myth

I don’t have any family ties so I’m single, free and independent.

Reality & Suggestions

Even in this case you will come across contingencies like medical problems, accident, etc. Unlike people with family folks around, you don’t have near and dear ones to support or stand by you in times of distress. So you need to be double careful to be prepared for contingencies.

Since you have enough savings and funds you have to invest it in good avenues regularly and build a secondary or tertiary source of income to take care of your retirement and extra income needs.

Important Financial Tips

Now that we know the myths that young people have are wrong and highly contagious its time to act. A few tips for the most frequently encountered problems are below:-

  • Don’t borrow or take too many consumption oriented loans (like personal loans, car loans, etc). If you have too many loans start closing a few of them
  • Some good loans to consider are home loans and education loans
  • Don’t overspend on your credit card. Use sparingly and pay the bill fully on time. Do not roll over the credit card balance unless it is an emergency case. Even in case of emergency try paying it off ASAP.
  • Pay yourself first: Start an automatic savings fund (a separate bank account) to which you will transfer some fixed amount every month. This is just to inculcate some discipline. The money in the savings fund can later be invested in appropriate investments after doing some research and homework. Irrespective of whether you invest or not maintain this savings fund judiciously
  • Tax Planning: When you plan your finances, think about tax benefits or deductions too. But this should be one of the factors- not the sole factors for your investment decisions. Don’t lock your money in 10-year bonds just for the sake of saving tax, instead look for alternate options. People in higher tax bracket can think of buying a house using home loan to take advantage of tax deductions, which can minimize your tax out go (deduction) every month. There are other tax planning methods which you can explore after consulting tax experts.
  • Health Insurance: We discussed life insurance and its importance. Similarly health insurance is equally important given the high cost of medical care and sudden health issues which can bring your daily routine to a standstill. Any major health issue can impact normal living, so try to maintain good health, active lifestyle and have a health insurance or mediclaim policy.

The importance of financial planning is clear now. But more than this financial planning also provides an opportunity to generate an additional income/savings. You also get to learn about stocks, sectors, real estate prices, commodities, etc.

Remember that people who took the decision to buy a property early in their careers (1/2 decades ago) are now sitting on additional properties generating income month on month. Similarly people who invested in Infosys or HDFC Bank a decade ago are reaping the fruits of seeds sown long ago. (I’m not recommending any names here but these are just examples from past data). To sum up I recommend that you plan early and work systematically to achieve true financial freedom.

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About the Author

Sridhar is a financial analyst and his work experience spans areas of financial analysis, modeling, valuation and research on companies, specific sectors, etc. Sridhar is an MBA graduate with Finance major from Maharishi Institute of Management.

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