Savings tips for young earners

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Suresh Parthasarathy

Some guidelines on how first-time earners can invest their monthly surpluses effectively.

Janani and Ajay, both in their early twenties, have just begun enjoying the perks of financial freedom. But their respective parents want them to develop a savings habit early into their careers. While Janani's father wants her to buy a traditional life insurance, covering a major part of her salary surplus, Ajay's father wants him to pre-pay his education loan at the earliest. Though both parents are right in emphasising the importance of savings, their suggestions may not really be the best thing. Here's a brief guideline on how first-time earners can deploy their monthly surpluses effectively.

Insurance: It is not uncommon for first-time earners to buy traditional insurance plans, but most do so without evaluating their merits. Young investors should understand that insurance is for protection and not an investment product, as such. The return from traditional products such as endowment will not even offset inflation, hence it's not a good investment option for young investors. If you don't hail from a wealthy family, it is prudent to buy term insurance. Term policies do not give maturity benefits at the end of the policy term, but ensure that the family has financial support in the event of the policyholder's death. And given the age factor, premiums for term insurance are quite low, making them easily affordable.

For instance, for a 21-year-old male, looking for a sum insured of Rs 25 lakh, the annual premium outgo would only be Rs 3,000 for a 30-year term (young women can get the same for a couple of hundred rupees less). The premium outgo is constant throughout the term of the policy. In contrast, in an endowment policy, even for a sum assured of Rs 2 lakh, the premium outgo will be Rs 9,400. It may also interest you to know that the premium paid for term insurance is allowed as deduction under Section 80C.

Accident insurance: It is also advisable for young adults to have a personal accident cover plan. It's specially designed to protect you from the following unforeseen events — Death, Total Disability and Permanent Partial Disability. This comprehensive policy will help your family meet its financial commitments in the hour of need. For a cover of Rs 5 lakh, the annual premium will only be Rs 590. And if you aren't covered under group health insurance, do insure your family.

Credit cards: Some of you may have come across reports of this person who has 66 credit cards! But what's interesting here is that not only was he effectively managing them all but he was also making profits out of them. The lesson here is that if you aren't disciplined enough, plastic money can be a curse! Considering their revolving credit concepts, you may end up paying exorbitant interest rates if you aren't organised.

So, however fashionable it may be to flash your credit cards to buy merchandise, remember to keep your spend well within your means. After all, though credits cards don't have a bearing on your immediate cash flows, there is no escaping paying them. So ensure that you swipe your credit card only for the amount you are comfortable paying up in that billing cycle.

Emergency fund: Gone are the days when job security was a given. Besides, it is very common for young people to hop jobs or opt for higher studies. It may, therefore, be prudent to set up an emergency fund to fund your requirements during the transition period. You can build the fund by allocating a particular amount every month towards the emergency fund. Make sure that any point in time the emergency funds amount to 2-3 months of your salary credits.

Education loan: With education costs skyrocketing, parents are increasingly taking bank loans to send their children to good colleges. And since education loans are offered with a moratorium period, most parents are eager to close the loan once their wards take up jobs. With interest rates going up to 12 per cent, while it does make sense to repay the debt, don't rush to repay the loan with your entire surplus as you get tax benefits on such loans. It is important that you understand the priorities and spread your surpluses accordingly.

Tax Planning: By planning your taxes well, you can avail the maximum tax benefits as provided by the income-tax Act. But since each tax planning instrument has a different investment objective, you will have to understand it well before investing. More often than not, individuals give up investment strategies to avail tax benefits. For instance, young investors invest in NSC or bank deposits (interest 8.5 per cent) in the last month of the financial year rather than investing in equity linked saving scheme (ELSS) where they have potential to earn higher returns with lower lock-in period. The category average five-year return of ELSS is 16 per cent against 8.5 per cent for FDs. Also, avoid planning your taxes at the last minute.

Investment: Young investors should understand the risk of investment before committing to it. While it is not advisable to invest in equities before understanding their dynamics, it is not advisable to stay away from them either. Investments in equities, spread over the long-term, have the potential to deliver significantly! And if you aren't keen on taking up direct exposure to equities, you can consider investing in mutual funds. You can start a SIP on any mutual fund scheme with a good track record. A sum of Rs 3,000 per month can become a crore in 30 years if the fund returns 12 per cent per annum. The savings can also be utilised as margin money while taking a home loan ten years later.

(This article was published in the Business Line print edition dated January 23, 2011)
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