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Financial mistakes young investors should avoid
If
the youth want to build long-term wealth, they should do away with lame
excuses about managing money and develop good financial habits that can
serve them well in later life
Ihave discovered a common characteristic among the
young people who have begun to earn and feel good about it. They do not
engage seriously with money or investment decisions. There are several
excuses—not enough money; too many choices; very complex; uncertainty about
where to start; too much paperwork. While they procrastinate about money,
they allow their money life to play out by default. Lets consider a few
common issues.
First, many young earners think that managing money
is complex and is not for them. This is when they have already opened a
bank account, taken a credit card, and a loan for a motor vehicle. Money
decisions have to be taken by default or design once you start earning. The
simplest way to understand personal finance is to see yourself as an asset
that generates income. If you save and invest, you are buffering the
income. If you spend more than you earn, you need a higher or an alternate
source of income. If you borrow, you create a liability and take away from
the future income. Beyond these four ideas of your assets, the income they
make, the expenses you incur and the loans you take, there are no personal
finance decisions to take. Evaluate every money decision in this context.
Second, youngsters tend to whine and complain when
the world they see and experience is different from the comfort zone that
they are used to. They revel in the problem, become cynical, crib about how
it makes their life difficult, and spend too little time on solutions.
Protective parents make the process of growing up tougher. The simple rule
is that money decisions require action, and this calls for evaluating the
alternatives and making a decision. I have known of intelligent students
processing complex case studies in class, but unable to fix a healthy meal
for themselves at the hostel. They do not see that this problem also
requires a similar solution-oriented approach, with real-life constraints
of time, energy, resources and skills. The 2-minute noodle has been a
hostel staple for way too long. This quick-fix approach continues in the
young people’s money lives, where the search is for quick, comforting
solutions that are easy to arrive at. Young investors need to think
strategically as if they were a business unit. Without this orientation,
they may remain clueless earners, who do not know how to take money
decisions.
Third, procrastination about money is simply
irresponsible behaviour. There are several youngsters who have not opened
their bank statements, haven’t deposited the dividend cheques, not filed
the tax returns, or completed the KYC process with a mutual fund or broker.
They have a PAN card since the employer insists on it. The taxman would
want to know if they can establish how they built their assets, and whether
they paid the taxes on their income before doing so. Those who share
transactions for fun also create short-term capital gains that are taxable,
and there are penalties for not paying these. Assuming you won’t get caught
is a bad idea.
Keep empty shoe-boxes to store statements, bills,
papers, and notices and take the time to sort them periodically. Form
groups to know how to file your tax and do it on time. These habits, if
developed early on, will help as you move up in your career and can afford
to hire someone. You can avoid being ripped off if you deal with your
paperwork in the early days.
Fourth, several young investors are overconfident
about their future incomes. They believe that they can find a new job since
a growing economy like India would have opportunities. They also are big
spenders since they do not visualise a dark future for which they have to
set money aside. Instead of defining saving as the amount left after
spending, it might be a good idea to set some money aside right at the
start. The direct debit options that take money away from the salary
account, systematic investment plans that ensure money is invested
regularly, and deposits that are created when the savings account reaches a
limit, are all good options to ensure disciplined saving. To spend is to
make the seller rich; to save is to make ourselves wealthy. It always makes
sense to pay ourselves before paying everyone else.
Fifth, young investors are very tech-savvy
and should find out how modern technology can
impact their financial lives.
The high default in educational loans comes from
ignorance about technology that credit bureaus can use to aggregate
repayment records. When the home loan is rejected because one fails to pay
an education loan, it is too late and expensive to make amends. The core
banking solutions ensure that money can be easily accessed, used and
transferred without recourse to a physical branch, by using Internet and
mobile banking instead. This, however, also means dealing with new risks of
password protection, guarding against phishing and Internet frauds, and
keeping an eye on salesmen who ask for account access to ‘make it easy’. It
is now possible to aggregate all the money transactions into applications
that help budgeting, spending, investing, and recordkeeping. The youngsters
should leverage their ease with technology to make money transactions
simpler and more efficient.
Sixth, many young investors start at the wrong end
of the investing spectrum. Several think that speculating in stocks, buying
a few IPOs, or conducting derivative transactions are the easiest ways to
make money. It is pertinent that various management schools have stock and
derivative trading games, not ones on asset allocation. The former is a
high-adrenaline activity that creates a buzz; the latter is a life skill,
but quite boring. A solid foundation for creating wealth is through simple
and staid products, such as fixed deposits and PPF accounts. Diversified
large-cap mutual funds and bonds can be added to this gradually. Speculation
comes last, and should only contribute marginally. Young investors need do
build a solid base first.
Young investors have time on their side. Anyone who
has dealt with money will be able to tell you how magically compounding can
work if good investment decisions are taken early on. It will be a pity if
this is frittered away due to procrastination or unwillingness to learn the
ropes.
Uma Shashikant, Managing Director, Centre for Investment Education and
Learning.
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