How new earners can start their journey to create long-term wealth

The earlier one starts their journey towards wealth creation, the more time he or she gets to grow and benefit from the power of compounding. This helps achieve even big financial goals with a considerably lower investment.

All the returns in life, whether in wealth, relationships, or knowledge, come from compound interest. - Naval Ravikant

The lack of financial literacy among new earners often leaves them ignorant about the importance of savings, and investment for long-term wealth creation. Salaries earned during the initial years are often spent on immediate lifestyle, entertainment & travel leaving investments for wealth creation for later years. However, savings and investments made during the initial working years can have a long-term compound impact on their financial well-being. 

Here are some steps new earners can follow while starting their journey to create long-term wealth,

Write down Daily Expenses

Writing your daily expenses will ensure that you know where your money goes. This will help you control your spending habits. Spend your money wisely.

Prepare a financial plan 

Financial planning is the process of creating a wealth management plan to achieve your financial (SMART) goals based on one’s income, investment horizon, and risk appetite. A financial plan provides clear direction to one’s investments with a disciplined approach and ensures regular investments at optimal risk.

One should start the process of creating a financial plan by estimating the amounts required for each financial goal with the predefined rate of return & time horizon to beat the inflation rate. Calculate the required monthly amount to be invested for that financial goal. A perfect financial plan also considers Life insurance cover (pure term plan), Health insurance cover, and emergency fund needs.

Asset class selection for long-term goals

Many new earners are ignorant about investment and if they think about it, they tend to avoid equities for long-term financial goals and prefer fixed income instruments such as bank fixed deposits(FD), public provident fund (PPF), and National Savings Certificates(NSC), etc. which are generally advised by their parents & uncles. However, the rate of return generated by these fixed income instruments cannot beat inflation.

Generally, Equity as an asset class has the capability to beat both fixed income instruments and inflation over the long term. Hence, young earners should start their equity journey by investing in equity, either in stocks directly or in mutual funds. Mutual funds provide a combination of professional management and diversification at a much lower cost.

New earners should invest in equity mutual funds for any long-term (more than 5 years) financial goal. Equities are very volatile in the short term so it is recommended that they should invest in fixed income instruments like high-yield bank FDs for the short term.

Invest early through SIP

New earners tend to postpone their long-term investments like retirement planning and focus more on lifestyle expenses. These Essential and big financial goals are considered by them as something that can be worked out later. However, the earlier one starts investing, the more time investments get to grow and get the benefit of the power of compounding. This will help achieve big financial goals with a much lower monthly investment also it will get you more time to average out on any losses.

New earners can use the systematic investment plan (SIP) mode because it is the best way for disciplined regular investment, it also ensures rupee cost-averaging by purchasing more units when prices decline. This eliminates the necessity of timing the market for investments and monitoring your portfolio from time to time.

The longer you stay invested, the more money you make because returns compound. Morgan Housel in his book 'Psychology of Money' recommends that you take advantage of compounding by finding investments that perform consistently over time. This strategy will make you the most money because of the power of compound interest. How long you stay invested is the most important factor determining your investment success, even more than other factors that seems more important like annual returns. 

Housel explains this point with the stories of James Simons and Warren Buffett. Hedge fund executive James Simons is arguably the world’s best investor since 1988, his annual returns have compounded at 66%; three times the rate of Buffett’s investments. However, Buffett is 75% wealthier than Simons. This is because Simons only started achieving his 66% rate when he was 50, while Buffett has been earning 22% a year since he was 10 years old. Buffett is wealthier not because he’s a better or more intelligent investor, but because he’s been investing for a much longer period.

Appropriate Insurance cover

The primary reason for buying life insurance policies is to provide replacement income to dependents in case of a policyholder’s untimely demise. Ideally, life cover should be more than 15 times one’s average annual income. However, many end up buying moneyback policies and endowment policies that offer inadequate life cover and generate inadequate poor returns.

Young earners should not consider insurance as an investment and separate investment from life insurance by buying pure term policies for life cover and investing in mutual funds for wealth creation since Term policies provide large life cover at a very low premium. Buying a Term insurance plan at a young age has benefits such as low premium due to young age & being healthy, covering your other liabilities at a low cost, covering your loved ones early, etc.

Young earners should also buy health insurance policies with adequate cover to be prepared for medical emergencies like hospitalization considering 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 hospitalization costs.

These policies also lapse on changing jobs, leaving employees without medical cover till their new employer provides them with health insurance. Buying separate health policies at a young age while being healthy 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 emergencies arising from job loss, disabilities, illness, or other unforeseen unfavorable life events. Without an adequate emergency fund, one would be forced to liquidate long-term investments made for financial goals or to take personal loans at higher interest rates. This can adversely impact the financial well-being and long-term wealth creation objectives of a young earner.

Young earners should build an emergency corpus of 6 to 9 months of their monthly expenses. As financial emergencies can knock on our door any day, emergency funds should be held in savings accounts that allow instant withdrawals. Nowadays banking apps can help create FDs from mobile itself with which one also can park their emergency funds in multiple high-yield fixed deposits in smaller amounts.

Consult with Financial Advisor

Well-educated young earners even postgraduates can be financially illiterate. Even if they are the best in their field but being financially literate is a different thing. Knowing how to save and invest for growing that hard-earned money is more important than knowing how to earn the money. We go to Doctor for medical reasons, we go to a lawyer for law/court-related advice, we go to the mechanic or garage for repairing cars but we hesitate to take advice from a Financial advisor or investment expert. Financial Experts can guide young investors in their wealth creation journey.

In conclusion, new earners should start their journey toward their financial goals with proper financial planning as early as possible.