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Property investment might be the last thing on your mind this early on in your adult life, but is the key to financial security starting young?
Blogger: Rakesh Gupta, director, ARG Finance
Everybody wants a secure future, especially, when it comes to your finances. Of course, it would be awesome if you didn’t have to work hard to earn that financial security. But that doesn’t happen. Not only do you have to earn good money, you also have to save a portion of those earnings for your future.
When we are in our 20s and we had just started earning, saving money for future needs usually doesn’t cross our minds. We are young and single, and just want to make the most out of the freedom. However, that is the best age to develop the habit of saving, be it in dribs and drabs, as you’ll be giving more time to those bucks to mature in an amount that can actually help you secure your future. Why? Because of compound interest!
What is compound interest and how does it benefit?
In simple terms, compound interest is 'interest on interest'. So your bank balance is something like this:
Month 1: Principal (1)
Month 2: Principal (1) + Interest on principal (1) = Amount (2)
Month 3: Amount (2) + Interest on amount (2) = Amount (3)
Month 4: Amount (3) + Interest on amount (3) = Amount (4)
Now imagine adding a fixed amount every month to this pattern of interest. You can rapidly snowball your wealth!
Consider the investment pattern of three different people who invest the same amount on an annual basis (assuming a seven per cent rate of return):
|Name||Amount invested annually||Duration of investment||Total amount invested||Return on investment|
|Susan||$5,000||Aged 25 to 35 years (10 years)||$50,000||$602,070|
|Bill||$5,000||Aged 35 to 65 years (30 years)||$150,000||$540,741|
|Chris||$5,000||Aged 25 to 65 years (40 years)||$200,000||$1,142,811|
An interesting observation in this case study is that despite saving $100,000 more through an additional period of 20 years, Bill still ends up having less money than Susan.
Here, we see that Susan started saving when she was in her mid-20s while Bill waited until he was in his mid-30s. Despite investing with the same rate of return, there is a huge disparity in the amount they both end up having when they are 65. This can be explained by compound interest.
All of the investment returns that Susan earned in her 10 years of saving, accrue to the point that Bill cannot match up with her, even if he saves for an additional 20 years.
And finally, the case of Chris – he started early and maintained that investment for 40 years. In the end, he wins by taking home more cash than both the above cases put together!
This comparison first appeared in a presentation by JP Morgan Asset Management and explains why saving while you are young is the best decision you will ever make.
Most people are not able to save because they just don’t know how to, as saving is not in their habits.
How to keep a budget
It will help you in the long run if you start keeping a budget while in your 20s. With technology at your disposal, budgeting is easier than ever. You can now automate the process of managing your cash flow, budgets and bills at one place by having a free account on Mint.
Mint lets you set a monthly target for your expenditure in each category (groceries, bills and utilities, health, entertainment). It helps you track your expenses in real-time.
Mint also reminds of pending bills, so you don’t have to worry about due dates.
To make a budget, you need to first start breaking down your pay check to decide your spending, savings and investments. For example,
Why save for your future?
You can be prepared for emergencies
It is strongly advised to have liquid savings at hand to deal with emergencies. What if you suddenly lose your job or have to buy a new car? Your credit card can come to the rescue at such a time, but dealing with a debt can lead to a setback in your financial health.
The solution is maintaining a rainy day fund and some liquid cash aside to deal with contingencies. It would be good for you in the long run if you start by saving a small amount in your 20s. You can increase the amount later as your income also grows.
The amount of money you allot for your emergency fund can vary according to your needs. It is wise to keep aside three to six months’ of your living expenses so that you can handle inevitable expenses (food, electricity, mortgage) in the worst case of being handed over the pink slip.
Locking money in insurances is another way to save for emergencies. I know, we don’t bother ourselves with such things in our 20s, but any sudden health problem can cost lakhs. Not to mention, the stress it brings to the family. So, start researching about different insurance plans and sign up for one that suits you.
You can save for your goals
As a 20-something, we all have dreams and life goals. You may want to own a home someday or wish to travel and explore the world far and wide. Or if you are in your late 20s, having a family in the near future may be on your mind.
Prioritise these long-term goals and then understand how much and for how long you must save for each of them. You can consider having separate savings accounts for each of your goals.
You can deal with debt
Unfortunately, most students have to deal with paying off their student loans once they get out of college and it is a good idea to start saving beforehand. Most of the loans give you some grace period until you start repaying them. But with some money saved for the purpose, you can start paying off your student loan right away.
You might consider repaying your debts once you are older, but your expenses are going to invariably increase with time and the more you wait, the more difficult it will get. It will be wise if you tackle your credit card debt, for instance, in your 20s when your expenses are still under control. Do this strategically as repaying a large amount at once may leave you running out of your savings. Decide as to how much portion of your debt would be right to repay at a particular point of time.
Over to you
With some conscious effort, it is possible to monitor your cash flow and make a few wise amends without having to compromise on your lifestyle. It is always better to save a little bit of amount than save nothing at all.
If you start early, time and compound interest will be on your side and you can end up having more with less effort.