Congratulations!! I just came to know that you got your first job. That too a well paying one. And that too at a young age of 21. There is no feeling which can be compared to the high one gets on getting your first paycheck. Not having to depend on your parents for pocket money….Brilliant! You earn and spend as you like. You are the king!
Seems familiar? Just like the feeling you had when you started your career?
This post is my feedback to one of the questions asked in the Personal Finances Survey conducted sometime back. The exact question of a regular reader Nupur, is as follows (edited for brevity):
I have just completed engineering and got a decent job – which pays about Rs 40,000 a month. I am young (21) and willing to invest for future. I read your post on huge cost of delaying investing and don’t want to end up not having anything later on in my life. I want to secure and solidify my finances as soon as possible.
Once again I am positively surprised with the clarity of thought, which the new people entering the workforce have about money. I personally was never so sure about financial solidification and was more fascinated about the stocks and investing in general.
Luckily, when I started my career, I was posted in a very remote location for more than 2.5 years, and which had almost no places or avenues where I could spend my money! And you will be surprised to know that there were many months, where I ended up spending less than 5% of my monthly salary. 🙂
But lets focus now on how Nupur can manage her new-found income source…
For this particular example, I prefer not projecting too long into the future. Its best to weigh the benefits of managing your money prudently in even the first 5 years of your career. And that is because if I can prove that a well-managed cashflow for first five years is a very big win for someone who wants to create long-term wealth, then there is no need to further convince this person…and that is because the reader is already very smart…well proven by the question asked. 🙂
From my personal experience, I have seen that a majority of young people realize about the importance of saving money (and investing) only after a few years of starting out. They don’t even realize and the first few years of their career just rush through in a jiffy. And when they look back and see how much they have saved, there is nothing to talk about. First few years are spent in buying things you always wanted to buy for yourself, but never had the money to do so. You also buy gifts for people you care about and travel and enjoy life. I am not against all this and even I have done this. And then there are those uncles and family friends who will sell you those high-premium insurance plans, which you don’t need. 🙂
Once again I am digressing from the real topic…so lets come back to the topic of how to manage money when starting out in your career…
Now lets see what we know here…
At the age of 21, Nupur starts earning Rs 40,000 after tax.
She would be making some mandatory PF contributions, which would be matched by her employer too. I am assuming this contribution to be 10% of her basic salary. This would have to be matched by her employer. Assuming basic is 50% of the take home salary, total PF contribution (Nupur’s + Employer’s) is Rs 4000 (Rs 2000 each).
Now for evaluating the scenario after 5 years, that is when Nupur turns around 26-27, I have assumed that her salary would rise by a nominal 10% every year.
Shown below is the table, which calculates the amount accumulated in her PF account after 5 years:
A rough approximate, given the assumptions we have taken are valid, is around Rs 3.7 lacs. Not much considering that her starting annual income was more than that. But significant considering that this has been achieved by giving up just 5% of her monthly gross salary. Isn’t it?
Now this PF amount should not be considered as something that you can utilize in the short term. So it would be a mistake to depend on this if there is any emergency money requirement. And when Nupur switches her job after 5 years, she can get this corpus transferred to her new employer or she can withdraw it. But withdrawing PF is a big mistake, which results in significant damage to the process of wealth creation by compounding.
Now once she gets her salary every month after mandatory PF deductions, she has various expenses. Without getting into the details, I am assuming a decreasing component of expense as a percentage of annual income. Mind you, I am not saying that expenses are reducing. I am saying that as she grows older and her income increases, she will become more and more aware of benefits of reducing her expenses and increasing her savings. Atleast this is what the thought process should be.
So I have taken expenses as 50% of first year salary. Followed by two years of 40%. And remaining two years as 30% of the salary. All the while salary has been increasing at a fixed rate of 10% every year.
Table below details all the calculations about expenses and available surplus:
As you can see above, the monthly surplus is increasing every year. And this is achieved by a combination of rising income and decreasing percentage of expenses.
Now lets see how this monthly surplus can be managed effectively. I am assuming that Nupur is ready to put full surplus amount into savings and investments as all her expenses have already been taken care off.
Like most Indian parents, Nupur’s parents also (I assume) would be a little apprehensive about stock markets. They must have heard from many people that stock markets are risky and most of the time, people end up losing money. I am assuming this. And basis of my assumption is the general perception which most people of previous* generation have.
* If you are reading this website and are from the previous generation, then you don’t belong to this category and are financially smart and on your way to become rich. 🙂
So Nupur decides to save a small but significant portion (about 25%) of monthly surplus in bank Recurring Deposits. This augers well for her too as it can act as an emergency fund that she can use when required.
Assuming a nominal 7.5% rate and savings rate of 25% of monthly surplus, Nupur is on her way to amass about Rs 5.6 lacs by the time she has completed 5 years in job.
That was about safer investments (or rather savings). Now Nupur is smart. She knows the real power of investing in equities through regular small investments. So she decides to do a SIP of remaining 75% of monthly surplus in a few well-diversified and proven mutual fund schemes.
And as you can see in table below, her monthly SIP amount is increasing every year. And this is because her income has increased, her expenses as % of income have decreased, and consequently her monthly surplus has increased.
I have assumed a SIP return rate of 11%. Please note that this is just used for calculations, and in reality SIP returns are not such straight-line. They are lumpy. They can be as high as 50% in a year to as low as (-)50%. But average returns for last about two decades in India have been around 15%. So 11% is a safe-enough assumption.
So as depicted in above table, Nupur is on her way to accumulate about Rs 18.4 lacs in her SIP portfolio. Now that is not a small amount for a 26-27 year old to have.
But aren’t we forgetting something else?
Nupur also has Rs 3.7 lacs in PF, Rs 5.6 lacs in bank deposits. Add to this the amount available in her SIP portfolio, she has a networth of Rs 26 lacs.
Even if we were to discount it by 15% for some wrong assumptions and other realities (and I call it Life-Discounting), she would still have about Rs 22 lacs.
And this is for someone who started her career at Rs 40,000 about 5 years back and still does not earn an eye-popping salary. She still earns a decent Rs 58,000.
This shows that if managed well, then it’s entirely possible to reach a decent networth position within a few years of starting your career. Just to give you a perspective, Nupur’s networth position at the end of 5 years is approximately 3-4 times of her then current annual income!! And that is commendable by any standards. And if she continues this approach, she is well on her way to become really – really rich and a Crorepati even before reaching the age of 40.
You would have noticed that in this example, there is not evenone statement that says that she needs to beat the stock markets or anything. And she is actually underperforming the markets when I assumed 11% as the return expected from MF. So even after a theoretically bad performance, Nupur is well positioned in financial terms than 95% of the people her age.
You might say that it would have been wiser for Nupur to purchase a house early on in her career. And you might be right. But I still believe that initial years should be devoted to fortifying one’s finances and accumulating for long term portfolio, than simply paying EMIs.
You might counter-argue that one still has to pay rent, which is an expense. And in case of an EMI, you are paying the money and getting an asset. But we are still paying interest on the loan taken. Right. And interest paid is always an expense. 🙂
But this post is not a discussion about the pros and cons of real estate investing.
The above scenario calculation is what I could think off in response to Nupur’s question. I hope if she reads this, she has some more clarity on what she can do now. As for other readers, feel free to share your own thoughts about the question posed by her.
nice article. But i have a doubt. How she will spot the right MF in the pool of zillion funds around her?
You forgot a major expense coming up in her life around 25 – Marriage!
at 26, for a monthly income of 58K, an SIP of 30K, seems extremely unlike, given the expenses of living in a metero. And time might be next to impossible if one has a kid or is married.
1. I find the calculation of expenses a bit faulty. Rs 20000 pm in 1st year reduces to less than 16k in 4th year for example. Inflation will not allow expenses to go down in absolute terms. Even if she manages expenses efficiently, Rs20000/- pm through out the 5 years would have been a better assumption.
2. Taxation on RD has not been considered. From personal experience a liquid fund/ultra short term fund is more tax efficient and also more flexible in depositing & withdrawing.
3.Till one learns to select MFs, equity investments can be made in index funds.
Hi Gurjot
I focused in this post only on the saving, investing and creation of a corpus for her.
I understand that marriage might be on cards at that age. And if need be, she can use the funds saved in RD for that. But idea of this post was to discuss about how to manage the finances soon after getting into the active workforce.
Hi Ram
Easiest way would be to stick with the proven ones and ones which have been around for quite some time (seen both bear and bull markets). But if there is a concern that about individual funds, then probably going for index funds might make sense.
But in India, quite a few well managed funds have been able to perform better than indices. So choosing a few of these and few index funds should be a good enough choice for her.
Hi Asim
It can still be managed. Its not easy but not impossible either. But I can agree with you as this might be different from one individual to other. In the example used in post, idea is to highlight that its easy to accumulate a corpus quickly, if one prudently handles his or her money in the initial years of the career itself.
In any case I discounted my calculations by 15% (Life-Discounting) to bring down numbers to more realistic levels.
Hi Sid
My replies are given point wise –
1) My assumption was that in first year, people tend to spend a lot more than what is required due to new found money and to fulfil the desires held-up for many years. But I think you have point that it might not be so huge that it outweighs the expenses in 4th year. It is still possible but unlikely. Having said that, the life discount of 15% which I made will eventually brings down the corpus numbers to more realistic levels.
2) Ignored taxation intentionally for simplicity.
3) Agreed. If one cannot find good funds but still wants to take equity exposure, makes sense to go for index funds.
One important thing that anyone starting out on a job is to avoid LIC and other such companies “endowment” policies like the devil… They should understand that term policies started early are dirt cheap, and can help provide not just security, but ensure that the costs of life cover even much later on in life are really nominal…
For most people, Endowment policies bought by their parents in their names the minute they join a job (Mera beta ab kamaau ho gaya hai, time to “gift” him an LIC policy), end up being a HUGE drain on their savings, and can affect their investment capabilities enormously. I have umpteen friends and colleagues who have “invested” 50-70K or more per year in such policies.
Everyone around seems to have an “uncle who is in a bad financial situation” who would be helped by their making a policy! If it's not an uncle, it's a friend or friends uncle… Unfortunately, by buying such policies, the uncle does really well, at the cost of your financial future.
I could go on and on railing against “endowment” policies and their evil twin ULIPS! 🙂
dear dev if timing markets are difficult then y u want to put money in RD so that it can be invested during crash
Best article on personal finance finance I've read. I'm sure we've heard all this somewhere or the other. But the way you have put it together makes it so easy to understand!! Wow.. Great job!!
Thanks George. Glad you found it useful. 🙂
Very well said Bharat. 🙂
And even I am trying to get out of an old endowment plan which some 'uncle' of mine sold me when I was young and foolish. But its tough now as we are family friends. I have anyways started treating it as a sunk-cost. If I can get something out of it, then its great. Else I will move on ;p and book my losses
Good to know that even savvy investors like you have made this kind of mistake in their “young and foolish” past! But I think you're still in the “Young” part, if not the foolish one! 🙂