Why new earners should create long-term wealth and how to go about it

The lack of financial literacy among new earners often leaves them clueless about long-term wealth creation. Lower salaries during the initial years of their working lives often lead them to focus on immediate lifestyle and income upgrades, leaving investments for wealth creation for later years.

However, investments made during the initial working years can have a long-term positive impact on financial health. Here are some wealth-creating financial moves for new earners:

Prepare a financial plan 

Financial planning is the process of creating a money management strategy to achieve various financial goals based on one’s cashflows, investment horizon and risk appetite. A financial plan provides clear direction to one’s investments, ensures regular investments at optimal risk, and helps instil financial discipline.

One should start the process of creating a financial plan by estimating the amounts required for each financial goal, the presumed rate of return, the time  left for achieving a goal, and the inflation rate. Then, use online resources to calculate the monthly contributions required to achieve those financial goals.

Equities for long-term goals

Many early earners tend to avoid equities for long-term financial goals and prefer fixed income instruments such as bank fixed deposits, public provident fund, and National Savings Certificates. However, the rate of return generated by fixed income instruments rarely outperforms inflation rates.

Equity as an asset class beats both fixed income instruments and inflation by a wide margin over the long term. Hence, young earners should start their equity journey by investing in equity mutual funds. These funds provide the combination of professional investment management and a greater degree of diversification at much lower investments.

Early earners should invest in equity mutual funds for any financial goal maturing after five years. As equities can be very volatile in the short term, they should invest in fixed income instruments like high-yield bank FDs and debt mutual funds for goals maturing within five years.

Invest early through SIPs

Early earners tend to procrastinate their long-term investments and focus more on lifestyle expenses. Crucial and big-ticket financial goals like creating a retirement corpus are considered something that can be worked out later.

However, the earlier one starts investing, the more time investments get to grow and benefit from the power of compounding. This will help achieve big-ticket financial goals with a much lower investment.

Early earners should opt for the systematic investment plan (SIP) mode because it instils financial discipline through regular investment. It also ensures rupee cost-averaging by purchasing more units when share prices decline. This eliminates the requirement of timing investments and monitoring the markets.

Prioritise term, health insurance

The primary reason for buying life insurance policies is to provide replacement income to dependents in case of a policy holder’s untimely demise. Ideally, life cover should be 10-15 times one’s average annual income. However, many end up buying unit-linked insurance plans (ULIPs), moneyback policies and endowment policies that offer inadequate life cover and generate sub-optimal returns.

Instead, young earners should separate investment from life insurance by buying term policies for life cover and investing in mutual funds for wealth creation. Term policies provide large life cover at a very low premium.

Young earners should also buy health insurance policies with adequate cover to reduce financial risks emanating from hospitalisation and rising healthcare costs. While many employers cover their employees under group health insurance policies, the cover provided by such policies is usually inadequate to meet hospitalisation costs.

These policies also lapse on changing jobs, leaving employees without medical cover till their new employer provides them with health insurance. Buying health policies at a young age will enable one to cover a higher number of diseases at a lower premium.

Emergency fund

New earners should create an adequate fund to deal with financial exigencies arising from job loss, disabilities, illness or other unforeseen adverse life events. Without an adequate emergency fund, one would be forced to liquidate investments made for crucial financial goals or take loans at higher interest rates to deal with financial exigencies. This can adversely impact long-term wealth creation objectives for a considerable period of time.

Young earners should aim at building emergency funds big enough to meet unavoidable monthly expenses such as daily living costs, utility bills, EMIs and SIPs, insurance premium, rent, and children’s education fees for at least six months.

As financial exigencies can strike any day, emergency funds should be held in high-yield savings accounts that allow instant withdrawals. Those comfortable with mobile banking and/or internet banking can also park their emergency funds in high-yield fixed deposits of scheduled banks.