How to manage your finances when you get your first job?

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:
Monthly Income Provident Fund
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:
Monthly Expenses Savings 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.
Monthly Savings Recurring Deposits
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.
Monthly Investments Salaried Employee
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.


If I Was Just Starting My Investment Journey in 2014, Here’s What I’d Do

In last few posts about Indian markets making new highs in 2014 and possibility of Sensex reaching 40,000 in next two years, I have been quite vocal about the recent rally. I have a strong feeling that Indian markets are pricing in a lot more positive news than what is actually possible in reality. In simple words, it’s the over optimism about the next government that is driving the markets now instead of fundamentals.

Just today I had a chat with a colleague of mine who seemed much more confident about Sensex reaching 35,000 in next 1 year than he was about Fixed Deposits giving more returns than Savings Account. 🙂 🙂 🙂

But when old timers like this person are so excited about future of stock markets, then can we blame the new ones entering it now?

I don’t think so…

Over the last few days, new recruits have joined my organization (employer). For sake of introduction I had a small talk with these guys. And the small chat made me realise that they were well on their way to commit the typical newbie mistakes which are quite normal in rising stock markets. These people are yet to get their first salaries and they are already sure what they want to do with it. If it was just about shopping for things which they always desired but never bought, then it would hardly have been an issue. But rather they are interested in putting their first salaries in deadly F&O (Futures & Options) game. And that is what concerns me. F&O are instruments where you can loose more than you invested. And I am sure that these guys are yet to understand this harsh truth.

To put it on record, I don’t think it’s a good idea for them to get into F&O…

And for benefit of many students who have recently joined their first jobs, I decided to jot down a few pointers….

Young & Fresh Out Of College?? Read Below…

College Graduation Job
Done With Studies? How to manage your money starting from first salary.

  • Stock markets have rallied sharply. It’s very easy to feel that markets are the place to make a quick buck. But this not true. Its tough to consistently make money in stock markets. Period.
  • You might think that because markets are continuously rising, there is no risk in stocks and it will continue going up. This is also bull shit. Higher (& quicker) the markets go, riskier it gets.
  • No matter what your parents, new colleagues or friends tell you, just buy a simple life insurance Term Plan before investing even a rupee in stock markets. Do not go for endowment or money back plans or ULIPs.
  • Do not buy stocks now. Its not a very good time to start investing. Just wait for a while now.
  • But if you still want to go ahead and buy stocks, keep a small amount as your ‘play-money’. Use this money to buy shares you want. But…do not add any additional money even if your investments become profitable from the very first day.
  • Start paying off your education loan as soon as possible. (if you have it)
  • Do not use credit cards just because it gives you reward points.

Stick with what I have said above and I assure you that you won’t regret it when sanity and common sense returns to our stock markets. 🙂 🙂

And if possible, read this.

Happy investing and be careful out there.


Mailbag: 22 years old & ready to invest for 25 years!!

A young reader (Dhruv) in his early 20s asked us a question. He has 25K to spare every month. He wants to know his options if he wants to invest this money (every month) for next 25 years. As we mentioned earlier also in our previous post, we are delighted to see that people ready to commit to long term wealth building for decades and not years. 🙂
So in this post, as we promised, we will try to address our young reader’s query.
But remember, there is no perfect way. People might take different roads to the same goal. So, go ahead and do let us know of your views in comments section.
Theoretically, putting aside 25K every month for next 25 years in a simple PPF account itself would create a corpus of 2.6+ Crore. And that is without even taking any risks. These are sure-shot returns. Unless the govt. and everything else comes crashing down.
But since you are young, it makes sense to take some risks. And with time horizon which you have, many (if not all) risks of so-called risky assets can be evened out.
We don’t know much about you, your family or your financial background. We only know two things. You are ready to invest 25K every month. You are ready to do this for next 25 years. Due to lack of important information, it is fundamentally not possible (and unethical) to suggest anything concrete here. Therefore, we will make certain assumptions and then give our thoughts.
  1. You are ready to invest 25K every month NOW.
  2. You don’t have any liabilities NOW.
  3. Your income (salary, etc) will increase every year for next 25 years.
  4. Your liabilities will increase in future (not uniformly though). i.e., you would need to fund your higher education, marriage, honeymoon, parent’s health, property purchases, etc.
  5. Hence we assume that though your income would increase, you will not be able to increase your contribution to investments. Your investment contribution would remain fixed at 25K per month.
  6. You and your family are adequately insured.
  7. You and your family have adequate health insurance.
  8. Though glamorous, we have chosen not to include individual stocks as an asset class for your wealth creation plan. It requires effort and passion. Since we don’t know much about you, it is best to avoid it. 🙂
What We Suggest
  1. Before even thinking of investing, keep aside 6 month’s expenses worth of money in some liquid asset classes. You can keep it in a savings account or an online fixed deposit. These days it’s easy to make (and break) online fixed deposits when required. So this should take care of your Emergency Fund.
  2. From the 25K, you should put in 10K (8.33K to be exact as there is a limit of 1 Lac on investing in PPF each year)* every month in a PPF account. This would turn into around 85 Lacs in 25 years. Now this is separate from your and your employer’s PF contribution. Remember, you cannot touch this money before 15 years (though you can withdraw some after 6 years, let’s not get into those details).
  3. For the remaining 15K, chose 4-5 good mutual funds. As one reader suggested in the previous post, it is better to stick with index funds when considering such long term horizons. That way, dependencies on fund managers and his team are reduced to almost nil.  So you can go ahead with 3 index funds (4k, 3K, 3K = 10K). But it is also advisable to pick two well established actively managed funds (2.5K each). These funds should have been in existence for more than 10 years and should have proven the mettle in multiple market cycles. For names of such funds, check out our last post and its comment section. This 15K every month for next 25 years would create a corpus of around 2.2 Crore.
Problems which you might face in future
Now suppose that you want to buy a property after say 5 years. You would definitely be tempted to take money from this corpus which you would have created in last 5 years. Now though this approach looks sane and full of common sense, the problem would be that this would break the COMPOUNDING. Once compounding breaks and you continue to invest for next 20 years (after 5 years from now), your PPF contribution would have become 52 Lacs & MF would have become 1.2 Crore (Down from 2.2 Crore in previous case). So, you should plan your big expenses in such a manner that you long term compounding is not interrupted.
So how can one do this? Though it may not seem like a good idea at first, what you can do is to reduce this 25K contribution in PPFs & MFs to around 15-20K. Park the remaining money every month in some recurring deposits or income funds. This way, you would have started preparing yourself for future expenses and would not be required to interrupt compounding of your investments.

Hope that helps. Others are welcome to pour in their thoughts.

* – Thanks our reader Hemant Bhatia for bringing this to our notice.