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Six Financial Mistakes

How many of us know that the social security net in India is almost non-existent? And that your EPF is a very poor attempt at creating social security. NPS, a slightly improvised version, is yet to gain acceptance, thanks to its complexity and poor taxation structure. In such a scenario, it becomes imperative that we save enough for our retirement.

However, young people who join the workforce, are not geared towards financial prudence and do not start thinking about savings and investment right away. So here is a list of six mistakes one should avoid making early on in their financial life.

1. Delaying the habit of investing

Having spent our college lives on shoestring budgets, when we get that first salary credited to our bank account, we have a tendency to splurge. But hold on for a minute, this urge to spend now can get you into trouble later on.

The chapter on compound interest you had in school was not just theory. It is now time to see that into action. When you make any investment, your returns get compounded every year. The earlier you start investing, the more time your investments have to compound. The more your returns compound, the more you will accumulate.

Take the case of Ajit and Manisha. Both of them started working at the age of 25. While Ajith started investing right away, Manisha waited till she turned 30. Both of them invested similar amounts, Ajit starting with Rs. 10,000 and Manisha with Rs. 15,000. They increased it by Rs. 1000 every year. However, when they turned 60, this is where they both ended up:

Difference in investment value

A delay of five years caused Manisha to fall short by over Rs. 2 crore. So start early to accumulate a sufficient amount.

2. Spending through credit card

As soon as you open a salary account, you will get a call from your bank to get a credit card. Credit card is just the thing a spendthrift needs. You spend without worrying and pile up your credit. You barely manage to pay the minimum amount every month. And very soon, you find yourself paying huge amounts of interest on the accumulated credit.

Credit cards come with very high interest rates, going as high as 42% per year. Spending money you do not have can get you into a debt trap. You will eventually find yourself spending more money paying the accumulated interest, than you spent for yourself.

3. Spending using personal loans

OK, so credit cards are expensive, but what about personal loans and EMI payments? You will be bombarded with ads offering you pre-approved personal loans at rates as low as 14%. They tempt you into buying goods you cannot afford. You may have only Rs. 30,000 in your bank account, but you take a personal loan for Rs. 40,000 to buy the latest Google Pixel phone. You will take another personal loan and go on a Europe trip with your friends.

Spending on luxuries you cannot afford will only eat into your corpus. Instead, plan for the long haul. Start with cheaper gadgets and trips closer home. This will help you save more in the initial stages of your life. As you move up in your career, you will have more opportunities to splurge.

4. Investing without understanding the product

Another mistake which people make is to not spend time understanding where they should invest their money. A young person tends to receive advice from his parents, uncles, senior colleagues, and these days, knowledge sharing social networks. None of these will understand your needs or advice you properly. Investing without understanding the product can land you into trouble, the kind which people got into last year when they invested huge amounts in Bitcoins.

You should neither rush to put your money in banks, nor rush to invest in equities. Nor should you fall into the trap of Ponzi schemes. So take a couple of weekends to think about your investments. Spend some time understanding the products available and the pros and cons of each. Then make an informed decision.

5. Trying to stay away from risks

While there are people who put their money only in banks, there will be people who swear by equities. Neither of the extremes are good. While you should not take too much risk, you should also not be too risk averse.

Equity and equity related products like mutual funds are risky. But they also come with risk premium. There is a reward for taking ther risk and this reward is higher returns. Over a long period of time, even 1-2% return differential can create a huge difference in your corpus.

Here is a comparison of how much a monthly deposit of Rs. 10,000 grows to in 35 years, at various rates of interest:

Value of investment at varying interest rates

If you stay away from risk, you risk missing out on the huge potential of equities.

6. Buying a home too early

We have a great emotional attachment to our homes. Owning a house is also associated with social status and prestige. As a result, as soon as we start earning, we want to have our own apartments. Within a few years, we find ourselves saddled with a huge home loan, zero savings, and only one illiquid asset that is the apartment. The next few years are spent paying the EMI only. By the time we can start saving, we have already missed the early bus.

Don’t be in a hurry to buy a house. Again, after having saved for a few years and after having made some progress in your career, you will be in a much better position to buy a house according to your needs. Taking a home loan early on not only gets you into a financial mess, it also restricts your career choices.

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SIPs and vacation planning Doing SIPs in your ‘vacation fund’ is a simple yet powerful way of accumulating corpus for your dream vacation

From Value Reasearch

The very thought of a vacation brings upon a smile on our faces. And why not? Vacation is something that most of us keenly look forward to. A vacation is not just about spending some time away from the hustle and bustle of our daily lives; it’s also about experiencing something new and spending cherished moments with your family. Indeed, many of us rediscover ourselves and our near and dear ones when we are holidaying.

But for many, a pleasant vacation remains just aspirational. From the demand of our professions to urgent monetary requirements, there are ample reasons that keep us away from saving for a vacation. As in most cases, careful planning can make things better here, too. If you already have the will to go on a dream vacation, there is a way – systematic investment plans or SIPs. Anyone can go on a dream vacation only if he/she takes the time to invest systematically and stay disciplined about it.

If the idea of planning and systematic investing makes you yawn, please be assured that it is the simplest and the most effective way to build a vacation corpus. The whole challenge is in initiating the process. Once you have committed to planning and saving for your vacation, the rest is just a matter of time.

So, what should you do? You can create a ‘vacation fund‘. In this fund, you can do monthly SIPs. You can start small if you can’t manage high contributions. Of course, you may invest in this fund after you have invested for your retirement and other crucial goals like the education and wedding of your children. With time, as your income increases, you can raise the SIP amounts going into your vacation fund. When you have the required corpus, you can withdraw from the fund. And voila, your dream vacation becomes a reality!

A good equity fund can act as your vacation fund. Equity can be volatile in the short run, but over the long term (five years or more), it gives good, inflation-beating returns. By doing SIPs in a good equity fund, you actually accelerate the growth of your money. It’s a proven fact that equity beats fixed income hands down. But don’t get intimidated by short-term volatility. Do keep a long-term horizon.

What’s more, share this SIP secret with some of your friends and they can also join you on the vacation. The more the merrier.

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The EMI that Comes Back

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The only cure for the EMI lifestyle is an EMI where the ‘I’ stands for investment, and not instalment.

A huge proportion of salary-earners see their salaries getting credited and immediately decimated by EMI withdrawals automatically made by the lenders. The beginning of the festive shopping season leading up to Diwali is a good time to think of this problem simply because this is the time of the year when the lure of buying things is at its peak. Offline and online, the ‘festive offers’ have already started appearing.

It’s now incredibly easy to make an EMI borrowing casually and impulsively. Once upon a time, there was a lot of paperwork to be done before you could buy something on instalments. Getting 36 or 48 cheque leaves from a bank alone used to be a struggle, not to mention filling them and signing them without any errors. Now, it literally takes minutes and that too with hardly anything more than standard ID proofs. In fact, even minutes is too long. For example, buyers can instantly convert credit card purchases to EMIs. Not just that, a large financial services company has an ‘EMI card’ which encapsulates a pre-approved EMI limit. Consumers can just swipe a purchase and have it added to an EMI. One can imagine the effect of having an EMI purchase process that’s exactly the same as a card purchase, specially when this is available for online purchases.

The problem with all this obviously is that people overborrow and end up paying a huge amount of interest. Effective interest rates on consumer goods EMI loans tend to be very high, around 17-20% currently. Moreover, hiding this interest rate appears to be a standard part of salesperson training. If you ask about financing at a white goods store, you will be told the actual rupee amounts. The salesperson will say something like, ‘Rs 11,346 down and then Rs 3,876 per month for six months.’ Calculating the actual interest percentage from this data is beyond the arithmetic capabilities of almost everyone, even if you have access to a computer right there. All that a customer thinks about is whether the sums sound payable. If they do, even at a stretch, the deal is done and a huge interest burden is committed to.

There’s no point complaining about the interest rates, as many people do, specially on social media. Small loans are an expensive and risky business for lenders, specially on consumer goods which have trivial recovery value. It’s a competitive market and if lower rates were possible, someone would be offering them. Many lenders offer supposedly zero rates but in those cases, someone in the chain is paying the money and it all eventually goes in to your purchase price. Really, there is no escape from the EMI culture.

Except, by creating a ‘Reverse EMI’ fund yourself. Just try it once and you will be convinced. Choose a fund suitable for short-term investing. Start an SIP in such a fund, one that you would comfortably pay in an EMI. Whenever you feel like buying something, see if there’s enough money in your ‘Reverse EMI’ fund. If there is, just withdraw it and buy what you want. Otherwise, wait. There’s no need to treat this as savings. This is an expenditure fund. From an interest expense of 17-20%, you will end up having a return of 6-8%. That’s a difference of 25%! That itself could pay for some things that you may otherwise may not be able to afford.

Specially, for young people, doing this on a small scale (maybe just to buy that high-end phone) can be a lesson in how time affects money. In fact, if you have a young one who is pestering you for some gadget, make a deal with the child and create a Reverse EMI fund. And then, use the differential between the EMI cost and your fund’s value to buy a better gadget.

It’s a great demo of the fact that postponing expenses creates money while preponing them destroys it. This is the central idea of all saving and investing, and one that can act as the basis of a lifetime of financial comfort.

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