Let's start with the famous quote of Warren Buffet "The most important investment you can make is in yourself." This Financial Cycle starts from the 'preparation Phase' which lasts from childhood until one completes his/her education (till early 20s). Then comes the 'Career/Profession Development Stage' lasting till mid-30s followed by 'Family Raising and Wealth Accumulation Phase' lasting till mid-50s.
After the brief period of the 'Pre-Retirement' phase, finally comes the 'Retirement Phase, the 'Wealth Harvesting & Preservation'. This is the stage when one would have achieved the financial freedom.
So, it is obvious that it is the 20s when the first step is taken to convert dreams into reality. Here is the time when one needs to balance the spending with savings.
To start lets briefly light upon 'the commandments' to keep in mind at this stage. First is 'start today to see the magic power of compounding'. At this stage, a person has relatively less responsibility, less financial obligations, low expenses resulting in higher saving power. And the earlier and more one invests, one will multiply the money that much quicker and higher.
Second is the 'know the difference between need, wants and desire to streamline one's expenses. Third is to be 'financially literate', i.e. to know the importance of financial planning at least if not the different avenues of investment along with return and risk associated with it.
Talking about investments, it will depend upon the immediate, intermediate, long term need and funds for any emergencies. Starting with the emergency fund, it is required for the 'rainy days'. This can be for any unforeseen circumstances or for those months where one might be either without job or switching.
Normally, 5-6 months average expenses should be the size of this fund. It can be built slowly and the best investment alternative in terms of return are, Saving Account, Fixed Deposits, preferably the Liquid Funds of mutual funds, or it can also be a combination of them.
The next investment requirement would emerge from future marriage and first house expenses. Thinking that one would marry in late 20's and will buy own home by mid 30's (assuming they don't have their own house), the most obvious option would be direct equity. This is equally risky as erosion in one or two scrips can ruin down the entire portfolio.
More importantly, the person would be lacking the necessary skills to choose the right stocks. So the best option is to invest in Equity Mutual Funds. But here too, one has the choice of many. Since many of the investors would be the first-time investors, the recommended funds would be Larger Cap Funds, Index based Exchange Traded Fund (ETFs) to start with.
The most common choice is Equity Linked Saving Schemes (ELSS) which comes with 80 C Tax Benefit. Going forward, with these funds performing, one can look into Midcap and other variety of other funds. The Systematic Investment Plan (SIP) is the most obvious and smart choice.
If you work today, tomorrow you will retire, even if one carries his/her own business. So, retirement planning should start from the first day of work. There are different methodologies available to find out the corpus required at retirement considering different factors like inflation, expenses, medical need etc.
The amount invested every year in retirement planning will keep on increasing as income rises. Nonetheless less, the available avenues are Employee Provident and Pension Fund (this would be deducted by your employer), Public Provident Fund, National Pension Scheme (provides retirement income with reasonable market-based returns with a combination of equity, government securities and corporate bonds) and the Retirement and Pension Schemes of the Mutual Fund. The annuity plan is also provided by the Insurance Companies. These plans come with various tax benefits.
Not all eggs should be put in one bag; the same applies to investment also. Some corpus should be kept in safe havens like Bank Fixed Deposits, Mutual Fund Hybrid Schemes (combination of Equity and Debt), National Saving Certificates, and likewise. This will provide the necessary and much-needed cushion and support to the investment.
Also important are the life and medical insurance. A modest amount of life insurance would be sufficient at an early stage which can be increased at a later stage. One should also opt for medical insurance with sufficient sum assured, again which can be risen at a later stage.
The all recommended avenues are guidelines. One should apply their own judgment and consult qualified financial planners for a suitable solution.
Lastly, the three S matters in early 20's. Sensibility, Self-control, and Suitability. Sensibility in decision making, self-control over expense, and sustainability of the choices one makes.
(The author is Assistant Director, ITM B School, Navi Mumbai)