Spending tips for youngsters

Being a young adult is challenging. It’s a time of your life when you start shouldering bigger responsibilities, yet you have a long way to go towards developing the maturity and wisdom needed to handle them.

While graduating from college life to a professional life, young adults have to contend with real life challenges such as paying rent with their starting-level incomes. There could often be a mismatch between their incomes and lifestyle expectations, leading to financial difficulties.

Here is a look at some common problems faced by young adults, and how to overcome them.

Paying off education loans
A typical young adult starts his working life, servicing a student loan. In India, the cost of higher education is at completely odds with the typical household inco-me, thus making families to take education loans.

Repaying one isn't easy; and not paying your EMIs on time means your interest piles up, and your credit score gets dented.

Paying off a loan is one’s legal and moral obligation. A loan at the start of your career is a difficult proposition, so let’s start with the obvious solution: Do not take any more loans, since your already thin resources will be depleted by the additional EMI. When you take a loan, get the longest possible tenure to keep EMIs at a manageable size. Start paying interest during the moratorium period. Once your income increases, lower your tenure and prioritise repaying your loan. You can use any bonus amounts, cash gifts etc. towards paying the loan. Needless to say, you should keep your expenses under check while you're in debt.

Preparing for emergencies
Life’s uncertainties are especially difficult to deal with when you are starting off in life. The emergencies could arrive in any form. For example, even though you are young and in the prime of your life, you could still have a health shock. You do not want your meagre savings to be wiped out by an unplanned hospitalisation. Young adults are often unprepared for these emergencies.

So young adults must start building an emergency fund — which means money tucked away in a bank account or deposit to tackle unplanned, short-term needs. For starters, this fund could be three to six months of their current monthly income. Secondly, they should purchase health insurance, which would keep their savings safe in case of a hospitalisation. A 25-year-old male can buy a health cover for Rs 5 lakh for premiums starting from Rs 4,600.

‘Good’ and ‘Bad’ credit
All credit is useful from the point of view of acquiring value. However, if we were to characterise them, there can be ‘good’ or ‘bad’ credit. Good credit helps you acquire assets whose value appreciates over time. Home and education loans are examples of this. They, not only help you create value, but also provide tax benefits. Bad credit may be taking a loan to buy depreciating assets and provide no tax benefits. Young adults, with their new financial freedom and credit cards, may struggle to differentiate between the two.

If you want to create wealth in the long term, you must have more appreciating assets than depreciating ones. In this regard, credit must be judiciously availed. For example, taking a two-wheeler loan may help you manage your work more efficiently. But taking a credit card loan to pay for a large screen TV may be a bad idea.

Saving & Investing
Savings are your income left after meeting all your fixed and variable expenditure. Investing is putting your savings in an instrument that can earn you interest or capital gains. Young adults often confuse the two. Maintaining a balance between spending, saving and investing is key to wealth creation in the long term. With their starting level incomes, youngsters may find it challenging to save, let alone invest.

One must always find a way to save and invest. Treat your savings as a loan to your future self. No matter how small your take-home income, you can find ways to set aside 10 per cent to 20 per cent.

No matter, how small the absolute value of these savings, it should be done. For example, start a mutual fund SIP to deduct just Rs 1,000 from your account at the start of your month, thus ensuring compulsory investing. Every year, as your income grows, you can increase this monthly investment by 10 per cent. Assuming you had picked a mutual fund that will provide a CAGR of 12 per cent per annum, this monthly investment will grow to Rs 91,000 in five years, Rs 3.07 lakh in 10 years, Rs 17.51 lakh in 20 years, and Rs 75.06 lakh in 30 years. And it all starts with a small sum of Rs 1,000 per month.

Separating wants & needs
Youngsters may easily mix up their wants and needs. Economists define wants as needs backed by purchasing power. Our needs are limited to essentials such as food, shelter, clothing, connectivity, and companionship. But our wants are unlimited. In the prime of your life, it is understandable for young adults to spend heavily on lifestyle choices such as entertainment, holidays, gadgets, etc. Spending beyond one’s means is also a function of peer pressure which young adults may feel. After all, it is too early for them to start thinking of more pressing matters such as buying a home or retirement planning.

Unchecked discretionary spending on lifestyle choices can dent your finances. Young adults must exercise caution while spending their limited incomes towards their wants. This doesn't mean that they must deny themselves the pleasures of youth. However, these should be done in a controlled manner.

The writer is the CEO of BankBazaar.com