Before you start investing, there are quite a few things to do to fix your financial position. The road that takes you comfortably and with a minimum of hitches does not begin with investing but is only a segment of the financial planning process. Even before you spend or invest a single rupee, make sure you have a stable financial base to ensure a secure future. Here are a few important things that not only a millennial but also someone in the middle age may consider before writing a cheque to make an investment.
1. Do not begin investing without a household budget in place
Most of us ignore its importance and follow an ad-hoc approach in meeting expenses. Get a proper household budget in place as it will help you to arrive at the amount of investible surplus after taking into account the total household income and expenses. While estimating monthly income, include the salary of both spouses. In addition, look at rent, dividend, interest income, if any. On the expenses side, write down the expense head such as groceries, school fees, transport cost, loan EMIs. Food and outings, travel, miscellaneous etc. For better clarity, segregate them into monthly, quarterly, half-yearly and on annual basis.
The findings! In doing so, you will notice a set pattern in your spending habits and may help you in cutting down some of them. You may also notice that there are certain months where the expenses are high compared to other months. Preparing a list to meet short-to-medium to long term goals will, therefore, become easier.
The budget check: To check if you are doing fine with your household budget, here’s a thumb rule to use. It’s called the ’50-20-30 Rule’ according to which, 50 per cent of one’s income should go towards living expenses including groceries, 20 per cent of savings towards financial goals and the balance 30 per cent towards spending, including outing, food and travel. One may even tweak the ratio and may adopt ’50-30-20′ pattern but ensure that you stick to it for a long term.
2. Get rid of all kinds of debt
If you have any form of debt, be it constructive debt such as home loan ( around 9 percent) or unconstructive debt such as car loan, personal loan ( between 13-18 percent) or even an outstanding balance on your credit card ( 36-48 percent per annum), make up a plan to get rid of it. Interest paid towards debt eats into the return that your investments generate. Say, you earn 12 percent on your investments and pay 12 percent on your personal or car loans, the net effect doesn’t help you to create wealth. Also, till the time the debt is repaid in full, make sure to keep paying EMI’s on time as it helps in shaping one’s credit history for the future.
Stick to a plan to prepay even your home loan as early as possible. Paying back the principal in the initial years of the loan is more benefecial than paying in the later years.
The findings! To know where your credit score stands, ask any of the credit bureaus to send a credit report. One can avail one free report each year.
The debt check: In order to avoid any squeeze in household finances, keep the total EMI’s including home loan not more than 50 percent of your take-home pay.
3. Get coverage for self and family
Even before you start investing, ensure adequate coverage for self and family members through an individual health insurance plan or a family floater health plan. In the absence of it, one may have to dip into the investments in case of any medical emergency. This may impact your long term savings. Also, if one has financial dependents, get adequate insurance preferably through a pure term insurance plan.
The protection check: As a thumb rule, one should have insurance cover of at least ten times of one’s income. Ideally, keep the insurance cover till the age of 60 or till the time your financial liabilities exist.
4. Make a blue-print of your goals
Even before you invest, have the short-medium and long term goals identified, their duration fixed and their indexed value determined. For example, if your goal is to save for child education, estimate its current cost and then inflate it to estimate the actual amount required after say 12 or 15 years. Knowing the exact requirement will help you invest the right amount, no more no less.
5. Build an emergency fund
No matter how careful one is in managing finances, there could be emergency events and situation in life. A sudden job loss or meeting uncovered medical expenses could be such events. In order to meet such exigencies, have an emergency fund in place. Such a fund may be created over a period of time and need not be built in one-go.
The emergency check: Park at least six months of household expenses in a bank savings account or short term liquid fund for this.
If you have addressed these five things, you are fit for selecting the right asset classes based on your risk profile and as per your financial goals.