It's in our 20s when we first taste financial freedom. It's the time to go all out and finally enjoy the dividends of all the hard work we have put in as students in the first two decades of our lives. However, while it's important to enjoy this phase, it is also critical to avoid certain mistakes that may impact you later. Here are some you need to be mindful of.
Not setting financial goals
Most people don't really think about financial goals when they start earning. They are young and just want to have a good time. However, when you set financial goals in your 20s, it ensures financial discipline right from the onset. In the absence of financial goals, you often end up over-spending which may land you in a vicious debt trap. Financial goals provide direction to your savings and investment. For example, you want to buy a car in a year, but you have invested most of your savings in high-risk equity mutual funds. As equities can be very volatile in the short term, you may be forced to redeem your equity investments at losses or delay your plans to buy a car till the markets recover.
Invest in SIPs of equity mutual funds for financial goals maturing after five years and in balanced funds for goals maturing between three to five years.
Thus, always align your investments with a set of financial goals, such as creating a corpus for your wedding expenses or for your car or home loan down payment. Identify the ball-park amount and time horizon required for each financial goal and calculate their required monthly contribution with the help of online SIP calculators.
Invest in SIPs of equity mutual funds for financial goals maturing after five years and in balanced funds for goals maturing between three to five years. For goals maturing in one to three years and for within one year, invest in short term and ultra-short term funds, respectively. If you are not comfortable with mutual funds, you can also go for options like PPF for your long-term goals, although they would provide you with a much lower rate of returns in the long run.
Not maintaining an adequate emergency fund
This is something that people of all ages struggle with. The main objective of this fund is to meet emergency cash requirements due to some unforeseen events or to meet your daily expenditures and mandatory obligations during unemployment. The absence of an adequate emergency fund may lead you to take expensive loans or compromise your financial goals by redeeming your existing investments.
Thus, try to create an adequate emergency fund by setting aside your mandatory expenses of at least three to six months. Invest this sum in low-risk investment instruments like ultra-short term debt funds to ensure liquidity and capital protection. These debt-oriented mutual funds not only generate higher returns than fixed deposits, their redemption proceeds are also credited to your bank account within three working days without any penal charges. You can also consider new-age banks that offer a high rate of interest on deposits.
Most young earners tend to underestimate the importance of having an insurance cover. Even those who buy insurance policies usually confuse insurance with investment and end up with high-cost traditional or ULIP policies offering insufficient life cover.
Starting early would allow your retirement corpus to stay invested for a longer time and hence, benefit more from the power of compounding.
As your total life cover, at any point of time, should be at least 12–15 times of your annual income, opt for term policies to adequately cover your life at low cost. Remember, the later in life you get an insurance plan, the higher will be the premium. Thus, get yourself adequately covered at the earliest. Similarly, get adequate personal accident and health cover to insure yourself against the rising cost of healthcare.
Not saving for retirement
Most young earners consider retirement planning to be a distant goal that can be deferred for immediate lifestyle expenditures or short-term financial goals. However, the rising life expectancy and the current trend of nuclear families have increased the need for large retirement corpuses. Starting early would allow your retirement corpus to stay invested for a longer time and hence, benefit more from the power of compounding. For example, a 50-year old person would require a monthly SIP contribution of ₹43,000 for 10 years at an assumed rate of return of 12% to create a retirement corpus of ₹1 crore while a 25-year old would require a monthly SIP contribution of only ₹5270 to create the same corpus.
As equities outperform other asset classes by a wide margin over the long term, invest in equity mutual funds to build your retirement corpus. Take the help of online retirement calculators to find out your ideal target corpus and the required monthly SIP contribution.
Not building your credit history
Generally, lenders consider your debt repayment history while evaluating your loan applications and increasingly, for setting interest rates. Absence of credit history will reduce your future loan eligibility for car loans, home loans, etc as lenders will find it difficult to evaluate your creditworthiness.
For those who have never availed loans in the past, the most cost-effective way to build credit history is to use credit card(s). While using credit cards to make purchases and payments is equal to availing loans, such usages do not involve any additional interest cost as long as you pay your outstanding card bills by the due date.