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Make sure you buy insurance products and set up an emergency fund
You may be eagerly looking forward to get going on your first job. But have you thought about how to manage your income? Here’s how you should plan your savings and investment in the initial years of your career.
You should first plan to protect your basic standard of living before aspiring to improve it. The first step would be to create protection assets. This involves buying two insurance products and setting up an emergency fund. You must first buy a life insurance policy, that is, a term insurance and not with-profit plans such as money-back policy and endowment plans.
Remember, life insurance is about indemnifying dependents (or beneficiary) for the loss of income due to death of the individual whose life is insured. What should be your life insurance cover? The sum insured is based on your income. So, you should increase your life cover in line with income.
You should also buy a medical insurance policy. Agreed, your employer may provide you basic healthcare cover. But this may not be enough because your employer may cap the maximum benefits under the plan. So, go for a super top-up plan to supplement your employer-sponsored health insurance. You should consider increasing the sum insured under healthcare plan, say, every five years for two reasons. One, you will face healthcare inflation as costs increase. And two, new health-related issues arise as you age.
You should also create an emergency fund. You will have to maintain this fund through your life; the corpus will increase as your lifestyle changes. To start with, your emergency fund should have at least three times your monthly expenses. Monthly expenses should be calculated as annual expenses divided by 12. That way, you will also include annual payments such as your motor vehicle insurance premium.
How should you create an emergency fund? Initially, transfer a fixed sum every month from your salary account to a savings account in a bank where you have no other banking relationship. You should follow this process till you create the required corpus in your emergency fund.
But what if building your emergency fund leaves you with limited resources to pursue other goals such as creating corpus to make down payment for a house? Remember, protection assets takes top priority. So, if you can initially save money for only one objective, you should choose the emergency fund. Defer pursuing other goals till you have accumulated the minimum corpus in your emergency fund. Then, if possible, increase the corpus in your emergency fund to six times monthly expenses.
The emergency fund is set up to meet medical emergencies and living expenses in case of temporary loss of employment. When you create an emergency fund, you may not crave for liquidity in your investment accounts; you can withdraw money from your emergency fund to meet short-term liquidity needs rather than use what is earmarked for buying a house.
This way, your investment account can hold attractive, but illiquid, products to meet your life goals.
Your emergency fund is unlike your regular investment accounts. Emergencies can arise often during your lifetime. The fund should be able to meet liquidity needs at all times.
This means it should always have the required corpus. If you spend some money to meet an emergency, restore the corpus, even if it means temporarily giving up your life goals.
The writer is the founder of Navera Consulting.