The late twenties and thirties are some of the most enjoyable years in lives of most people. You are likely to have settled well in your careers. Most people would still be in junior or middle management roles at this age; work is not likely to be as stressful as it gets later in your career as you move in senior roles with far greater responsibilities. You are likely to have a young family and at this stage of life you would not be worrying about your children’s careers as they are likely to be quite young. Your income is likely to be substantially higher than your income in early twenties when you started your career; you may be enjoying a good lifestyle.
While thirties is the time to enjoy life, you should be careful because you may get into financial habits which may cause trouble later in life. We come across many examples of people, with good careers at one point of time, facing financial challenges later in life. While everything looked good on the surface, the seeds of financial worries which people face later in life are often sown at a much earlier stage of their lives. In this article, we will discuss 5 signs which may indicate potential financial trouble for you in the future. The objective of this article is to make you aware of potential risks, so that you can work towards taking corrective steps for the long term financial well-being of your family.
Are you not paying your outstanding credit card loan in full every month?
Your monthly credit card outstanding may be Rs 1 Lakh but you have the option of paying the minimum due of say Rs 5,000. If you are availing of this option or paying less than what is outstanding on a continuous basis over a period of time, you are actually spending more than you can afford. In technical terms this is known as revolving credit. This may eventually lead you into a debt trap. Another sign of this potential risk is when you may have credit cards in your wallet and you use all of them, but pay the full outstanding only in a few. Credit cards enable you spend much more than what you have in your bank, but you should know that there is a cost associated with this kind of spending.
Interest rate of revolving credit is very high and over a period of time, the interest cost will be a big percentage of what you owe to the bank. Interest is a cost, which is entirely avoidable, if you can rein in your spending. It is a cost which goes out of your savings and leaves you with less money for your long term goals. There are many instances where the borrower had to redeem their long term assets like stocks and mutual funds to pay off their credit card dues. This may cause a lot of damage to your long term financial future and you are in a situation, where you are not able to pay your monthly credit card outstanding in full on a fairly regular basis, you should take a look at your expenses and control it. Your first financial priority should be to pay off your credit card dues in full.
Is your home loan EMI more than 40% of your monthly income?
Home-ownership is a deeply emotional investment. However, it is often difficult to cap emotional aspirations and often homebuyers over-extend themselves in purchasing their dream homes. This can have grave consequences when things do not work according to plan. When purchasing a home with a loan, you should understand what the home loan EMI will be. What percentage will the home loan EMI be of your regular monthly income?
If the percentage is too high, then you will have very little savings every month, after paying EMI and other essential expenses like school fees, utility bills, transportation costs and other day to day living expenses. You will not be able to save sufficiently for your other long term goals like children’s education, retirement etc, which are equally important, more than your property. Ideally your home loan EMI should be 20 – 35% of your monthly income, lower the better, so that you have sufficient monthly savings for your other long term goals.
What if you already purchased an expensive house and are paying high EMIs, which put other life goals at risk? There simply is no other option but to control your spending, invest it in assets like equity mutual funds or equity oriented hybrid mutual funds which gives a higher rate of return than your home loan interest rate and from time to time, use the asset returns to pre-pay your home loan principal, so that you can bring down your interest cost in an accelerated time-frame.
Do you have adequate life insurance?
Most of us buy life insurance, but is it simply for the mental satisfaction of buying protection for your family or are you actually providing sufficient protection. Rule of thumb says that your life insurance cover (sum assured) should be at least 13 to 15 times of your annual income. Why should life cover be 13 to 15 times of annual income? Death is a morbid topic and most of us do not want to think about it. But life is uncertain; an untimely death can cause a great deal of financial distress to the family. In order to prevent financial distress to your family, in the event of an unfortunate and untimely death, the maturity proceeds should generate enough monthly income to meet the needs of your loved ones.
Assuming a rate of return of 7%, a life cover at least 13 times of your annual income will be required to meet the expense needs of your family in the event of an unfortunate death. A higher life insurance cover, if you do not have adequate cover, will require you to spend more in premiums, but this should be looked upon as an essential expense for the financial protection of your loved ones. Different types of life insurance policies, depending on their features, have different costs. Our insurance advisors can work with you to identify the right policy for your needs.
Is your asset base sufficiently diversified?
There are numerous types of assets ranging from equity, fixed income, gold and real estate. It is usually seen that we are heavily invested in one type of asset like say, fixed income or real estate and under-invested in others. Lack of adequate diversification can expose you either to capital market risks, more than what your risk capacity allows or does not generate sufficient returns for your long term goals, which is another kind of risk.
If you are too heavily invested in equities, you will expose a large part of your net worth to the vagaries of stock markets which are intrinsically volatile in nature; a major bear market or a deep correction can cause a big dent in your investment. On the other hand, if most of your assets are in bank FDs and Post Office Small Savings Schemes, you will struggle to beat inflation on a post tax basis and create wealth for your long term needs. We have already discussed the risks of investing most of your savings in real estate. Gold, as an asset class, has its pros and cons. It is countercyclical to equities but can underperform for long periods of time. Also, the form in which you purchase gold (physical versus paper gold) has an impact on the economic returns.
A balance is required to get desired returns from your asset portfolio and at the same time, optimize risk and ensure adequate liquidity for your financial needs. Asset diversification plays an important role in achieving investment success. Studies have shown that asset allocation is a far more important attribute in investment returns than individual stocks and mutual funds. Our financial advisors can help you to determine your optimal asset allocation and work with you to achieve / maintain your desired asset allocation.
Have you started saving for retirement?
If you are in your late twenties / early thirties and the answer is yes, you are off to a good start on the road to your financial future. However, based on our experience over many years, the answer of the vast majority of investors to this question would be no. The challenge of retirement planning is quite substantial and not to be underestimated for your own benefit. There are many examples of successful people with good careers, who are now worried about their financial future after retirement. If you do not want to be one of them, you should start your retirement planning now.
The challenge of retirement planning is encapsulated in the simple 30 – 30 Rule. The 30 – 30 Rule implies that 30 years of savings made in your working career towards retirement, should pay for all your expenses during the 30 years of your retired life when you have no income other than that from your savings. If you think about it a little deeply, the challenge is not a trivial one. However, savings and investments can help you meet that challenge through the power of compounding. Let us assume you need Rs 2 Crores of retirement savings to meet your expenses during your retired years. How much do you need to save every month if your retirement age is 60, to achieve that goal, assuming 12% rate of return on your investment?
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You can see in the chart above that you can achieve your retirement goal with a much smaller regular monthly investment if you start early. You can see that the required monthly savings almost doubles, every 5 years you delay to start your retirement planning. If you delay it till the later stages of the career, your required monthly savings triples. You should also remember that once you approach middle age, 45 or 50, you have to also contend with other important life stage goals like children’s higher education and their marriage.
You can make a goal here – Retirement Goal,
As parents, we put our children’s interests above our own, if we have competing priorities. We are likely to compromise on our retirement savings for the sake of our children. From a holistic perspective, however, if we do not have sufficient retirement savings, we will burden our children in the future, if they have to take care of us financially during our retirement years. It is therefore, very important that we start our retirement savings early in life, so that we do not have to make the compromises many investors make and be a burden on children later in life. Mutual fund Systematic Investment Plans (SIPs) are wonderful investment options that can help you create substantial wealth for your long term goals through the power of compounding. You can work with our financial advisors to start your retirement planning with small amounts of investments and gradually increase your investments over time.
Conclusion
In this article, we discussed five signs which may not spell financial trouble in the future, but may not seem ominous at all when you are young. We want you to be aware that these five signs may have grave consequences for your future. It will be in your interest to correct these problems at a fairly early stage of your careers for the well being of your families. Our experienced financial advisors can work with you to ensure success in your short term, medium term and long term goals. If you have any question or need any help, please contact us at lordscal@easternfin.com; our financial advisors will get in touch with you.
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