Just landed your first job? You may think that your dream of attaining financial freedom have already come true. Not really. Attaining true financial freedom is not about earning a comfortable salary. It’s also not just about having control over day-to-day, month-to-month finances.
You achieve true financial freedom when you have the capacity to absorb a financial shock and are able to make the choices that allow you to enjoy your life.
But how do you get there? For this, you need to embark on financial planning. You may think, isn’t it too early to think along these lines, as you have just started working? Don’t people think of financial planning when they are a decade into earning or probably a decade before retirement? No. The best time to start financial planning is as early as possible. In fact, parents should have already inculcated this habit in you when you were a teenager.
Early planning helps individuals to examine their financial health, spending habits, taxation and investment. It not only reduces the stress associated with achieving financial goals related to purchases and emergencies but also provides capital or a cushion should you plan to change your career, take a break from work or start up on your own.
Have you heard the saying “Have a plan, be rich”? So plan today.
A good financial plan must focus on three main aspects: financial goals, smart spending and investment.
Know your financial goals: Having a clear idea of where you are and where you want to go financially is an important first step. If you aren’t working toward anything specific, you’re likely to spend more than you should. Hence it’s important to think about and list down both short-term (immediate to one-year horizon) as well as long-term (greater than one year) financial goals.
This is a very commonly heard advice but rarely followed. Deciding on goals as per time horizon will help you choose the correct instruments and their maturity to ensure that money is available when the need arises.
Spending smartly: Be a careful spender, because unless you don’t control your spending, making more money won’t help. Create a realistic budget, one that takes all your expenses into account. Avoid debt, especially one that comes with credit card usage. Prioritise your liability over your luxury spending. For instance, if you have a student loan or educational loan, pay them off first. Don’t take a car loan unless you really require it.
Investment and tax planning: Investing allows you to significantly grow your money over time. It takes money to make money. Young earners often find it difficult to pick the right investment strategy. Some confuse investment with tax planning. One must not be obsessed with investing just for saving tax – ULIPs and insurance products are cases in point.
People often play into the hands of agents who lure young earners with a promise of high returns and tax saving. Insurance has its own purpose (it’s not exactly investment) and so does every instrument. Not understanding the differences can lead to faulty investment choices thus leading to unfulfilled goals. So it’s important to strike a good balance between investing in the right instruments and maximising tax savings.
How to plan your investments and taxes
We have already discussed the need for beginning financial planning early for new working people in this article.
How do you start financial planning?
There are several investment instruments that one can choose in line with your goals.
–For short/near-term goals, you can park a part of your funds in recurring/fixed deposits or short-term debt funds.
–Medium term: Money can be invested in balanced funds or equity-linked saving schemes.
–Long-term: Equity mutual funds, NPS, PPF and EPF are good instruments for long-term growth.
Along with goal tenure, other factors like risk appetite, returns, taxation and liquidity must also be considered before you invest.
The following chart briefly explains various investment options considering the above factors
|Investment||Rate of return||Liquidity||Tax Treatment||Goal term|
|Recurring deposit||7-7.5%||As per tenure||No Sec 80C. TDS applicable, Tax on interest income if > 10,000||Short to medium|
|Fixed deposit||7.5-8%||As per tenure||Sec 80C only on 5-year Tax saving FDs.TDS applicable, Tax on interest income if > 10,000||Short|
|Balanced/debt mutual funds (5-year return)||8-9%||Withdrawal at will||No Sec 80C. STC @marginal, LTCG @20%||Short to medium|
|Equity mutual fund (5yr return on multi-cap)||12.5% approx||Withdrawal at will||No Sec 80C. STCG @15%, no LTCG||Long|
|PPF||8.10%||Lock in for 15yrs, partial withdrawal after 7yrs||Sec 80C
|NPS||9.47%||At 60 yrs||Sec 80C,
40% of maturity tax-exempt
|ELSS (5yr returns)||13.11% approx||3yr lock in||Sec 80c,
|ULIP (5yr return)||8.9% approx||5yr lock in||Sec 80c,
|GOLD ETF (5yr return)||6-7%||Withdrawal at will||No Sec 80C. STC @marginal, LTCG @20%||Long|
Maximise tax saving
For most young earners, as the salary is not too high, saving tax may not be a priority but it is important to be aware of taxation policies at the earliest. Get a good understanding of exemptions/reimbursements and deductions that aid in maximising tax saving:
Few ways of saving tax on your income are as follow:
- Restructuring Salary: One of the best ways of saving tax. You can restructure the components of salary to bring down tax liability. For instance: include transport allowance and produce bills for the expense incurred, or opting for Sodexo coupons. However, not all organisations permit this.
- Exemptions: One of the good ways to save taxes, especially helpful for people in the lower slab, the tax liability can be reduced to zero with the help of exemptions. Most popular and effective exemptions are HRA and LTA.
- Sec 80C: Maximum of Rs 1.5 lakh can be invested in tax saving instruments. This will be deducted from a person’s taxable income
- Home loans: Tax can be reduced up to Rs 1 lakh, from the principal amount of loan and unto Rs 1.5 lakh can be deducted from interest portion
- Donation: Sec 80G allows you to claim income tax rebate on donation. Based on charitable institution or funds, either 50% or 100% of donated amount is granted as rebate
- Medical Insurance: Rs 15,000 for self, spouse or dependent and Rs 20,000 in case of parents above the age of 65 years.
All told, earn more, opt for smart spending, and save in a way that aligns with your goals. So, set your goals and stay focused, because making money is a marathon and not a 100-meter race. It takes years of hard work. And, as rightly said by Warren Buffet, “No one has ever become rich simply by saving…money grows by proper planning…”