# Financial Planning in your 20s!

Last Updated: Fri, Jan 11, 2013 11:59 hrs

Why Financial Planning:

Einstein calls it the 8th wonder of the world. It has power to create enormous wealth for people who persevere and hold on to it. This is compounding rate of return. Compounding return is nothing but earning returns over returns as well as principal.

The wealth created by compounding rate works in favour of those who have larger earning period remaining in their life. This article will focus on such people.

I will worry about it later, I am young and I will have fun for now.

While this is certainly something that all of us do in our young age, we have to also build the discipline to save a part of our income and invest to reap benefits in future. The discipline that we build now will keep us in good stead years later.

Moreover, compounding works in the favour of people who start investing early than those starting later in life.

Here is a sample of the power of compounding.

It assumes a person starts investing Rs. 1 per month at various stages of his life till he or she is 65. It means if you are 25 years old, your investment horizon is 40 years while the horizon is 30 years for a 35 year old. The table also shows how your future wealth varies with the rate of return.

Investment = Rs. 1 PM, Investment Horizon = Till 65

 Your Age 25 30 35 40 Inv Period (in Years) 40 35 30 25 Rate of returns 8% 3,491.01 2,293.88 1,490.36 951.03 10% 6,324.08 3,796.64 2,260.49 1,326.83 12% 11,764.77 6,430.96 3,494.96 1,878.85 16% 43,194.23 19,470.17 8,753.76 3,913.04 20% 1,67,384.88 62,049.32 22,977.84 8,485.29 25% 9,53,990.08 2,76,821.52 80,301.76 23,270.15 30% 56,17,101.70 12,76,644.12 2,90,129.35 65,910.73

A 25 year old person who starts investing Rs. 1 per month at 10% return till he reaches 65 years of age will have Rs. 6324.08 while a 30 years old person will have only Rs. 3796.64. At 14%, you will have twice as much wealth than someone who started investing just 5 years later.

If you can start investing Rs. 5000 per month at the interest of 12% from 25th year, you will accumulate 5,88,23,850.00 (5 crore, 28 lakhs, 8 hundred and 50) by the time you turn 65. Does it really look like the 8th wonder? You bet.

Where to find money for investment?

Saving 5000 is not a big deal if you are serious about it. Even if you are able to save 2500, you will have close to 3 Crore at the end of 65 years of age, assuming you are 25 years old. The important point is that you save something.

Some of the things you can use to save money and invest in appropriate funds are as follows:

1. Pay your credit card bills on time. No exception.

2. Make a budget for your expenses. This may sound like a tough job but do it for 2-3 months and you will have a fair idea of where the money is going. You may not need to do it after the initial few months. Now curtail useless expenses. For example, going to an expensive restaurant 3-4 times in a week. Cut it down to once or twice a month.

3. Pay yourself first: Resolve to save a specific amount every month. Put it in an investment account. Take this money out of the salary in the beginning of the month so that you don’t touch it.

4. Buy a car or bike having resale value. If possible, buy a second hand car if you are too keen.

5. Stop splurging on sale and discount. You often end up buying things you never need.

Since you are in your 20s, you can invest major part of your savings in equity or equity funds which will not only protect your principal but will provide a healthy return. You also need to put 3-6 times your monthly salary in bank to face any emergency.

Most importantly, you should have a long term view of your investment. Remember that the 8th wonder works in the long term. Let’s see what options you have in the investment space.

1. Equity & Equity Mutual Funds: Equity investment is known to give the highest returns. Calibri;mso-fareast-font-family: "Times New Roman";mso-bidi-font-family:Calibri;This includes individual stocks, diversified equity fund, sector equity fund, index funds etc. Over a 20 year period between 1990 and 2010, Nifty has given an annualised return of more than 20%. However, the volatility of the returns is high which makes it riskiest of them all. The best idea is to find a few blue chip firms or a well-diversified mutual fund and invest for a long term.  A mutual fund is a fund that invests in a set of companies to diversify the risks (means if few companies go down, few others may go up to save your capital).

2. Bonds & Debt Funds: There are good quality bonds available from Government and Companies. These are fairly safe and returns can be between 8-12%.

3. Safest Instruments: There are others which are very safe, such as PPF, PF, Bank Deposit but they have lesser returns. Your company anyway does the PF for you.

4. Others: Other options could be ULIP, Gold ETF, and Index funds.

As a general rule, young people should invest a big part of their savings in equity or equity mutual fund. A generic rule states that you should subtract your age from 100 and you should invest that much percentage of your saving in equity & equity mutual fund. If you are 25 years old, you should invest 100-25 = 75% of your saving in equity & equity mutual fund and rest 25% in high grade bonds or bond funds. It has been shown that equity & equity oriented diversified mutual funds give the best returns over long term and you have time in your favour.

The typical returns from different financial instruments are as follows:

 Investment Options Average Returns Equity & Equity Funds 12%-20% High Grade Corporate Bonds 8%-14% Government Bonds 6%-12% Money market (FD, bank deposits) 3%-10%

However, before you start investing in the market, you must have 3-6 months gross salary in your savings account for any emergency.

Here is a typical asset allocation for a 25 year old person (assuming you already have sufficient money in your savings account for emergency purposes)

Building a strong foundation for your future:

It is extremely important to plan for your financial future. Often, in the case of finance, failing to plan is planning to fail.

Firstly, resolve to save a part of your salary every month and invest. If you cannot maintain the discipline, start a systematic investment plan (SIP) with a brokerage firm, such as ICICI direct, Kotak Securities, Angel Broking.

Secondly, have a long term view of your investment. If you look at any stock price or NAV of mutual fund, the prices go up and down in short term but generally go up in long term for good stocks and mutual funds.

And lastly, learn about investment, planning, and don’t hesitate in taking professional help. You work hard in your youth; it is natural but to lead a comfortable life when you retire. You deserve it.