In the first part I wrote about some fundamentals of interest rates and the rule of 72 and how using the rule of 72 you will know how soon you can let compounding grow your wealth. You can read part 1 here.
In the second part I spoke about the importance of taking insurance – life and health – before looking at making any kind of investments – because the earlier you take the insurance, the lower it will cost. If you are interested you can view the post here.
Today I will talk about the next thing you should look at before going in for your investment strategy. As you start your job, first ensure that you have your 3 months of expenses set aside. The job market is extremely volatile and you don’t know what is in store the next day. So you should always have money available in your savings bank which can help you meet your 3 months expenses.
You may think of 3 months expenses, equals 3 months salary because you end up spending all your salary every month. That’s not the case.
What you are looking at is the basic things you will need to survive for 3 months if you don’t have a job or don’t get salary for 3 months.
So this would include the rent for the house that you stay in. It would include the electricity bill and basic food requirements. Any loans that have to be paid back monthly and basic travel expenses. It will not include entertainment and eating out budgets. It will also not include holidays and tourism.
Typically the amount needed to survive at a basic level of sustenance for a human being is generally not much. If you will chart out your basic expenses you will realise that in most cases it’s not more than 30% of your monthly salary.
When I was young, I had taken life insurance as my first step. However I would end up spending all my money tht I would earn. Since I was living with my parents, I never felt the need to save. It was only after I had got married and I started staying independently and the company I was working for went in a downturn and we didn’t get salary for months. We did not having enough savings and we ended up buying things on the credit card. But because salaries were getting delayed the credit card debt started pilingup.
Which brings me to the next part. Never ever take credit card debt. I know in some countries, its necessary to improve your credit rating. You however need to understand before you start spending on the credit card, what’s the level of interest they charge on outstanding. Then use the rule of 72 which I explained in the first post. In India typical credit cards charge more than 3% per month, which means that your outstanding doubles in every 2 years.
So say you bought an item worth Rs/$100. After the first 30 days of credit you pay back the minimum 5% of the outstanding due – which is $5. This means $95 of the principle is now outstanding. Next month on this outstanding the company will charge 2.5 % which would mean your total outstanding (principle+interest) would become 97.38. At minimum 5% payment due next month you will end up with an outstanding of 92.3.
I have given above a chart of how your payment will scope out if you just keep paying 5% of the outstanding back. You will take more than 10 years to payback Rs/$100. Similarly if you were to pay 10% of the outstanding amount, back every month at the same level of interest, you would take about 5 years. But if you pay back 25% of the outstanding amount every month then you will payback in about 2 years. And all this is assuming that you have not made an additional expense on the card. Then the the whole chart will change dramatically
Now look at the amount you would have paid back to the credit card company in absolute money over the period of the time you were paying the interest and principle.
So when you take a credit of Rs/$100 and pay minimum 5% of the outstanding every month then you payback more than Rs/$3500 and when you are paying back 25% of the total outstanding every month then you will end paying a total of Rs/$ 431.
What the above is showing you is how compounding is working “against” you and “for” the credit card company. This is the reason people fall into a debt trap and are able to come out of it with great difficulty while all the banks and credit card companies are always growing.
So as a general rule take a credit card because you have to start getting a credit rating built but ensure you are always paying back everything in the interest free period. That way you can actually take advantages of the credit card. I will cover those in a separate post.
For now after you get a job, take an insurance for your life and medical/health. After that ensure you have a bank savings account which has minimum 3 months of coverage of basic necessities covered. Then go for a credit card to build your credit rating, but ensure you are paying back within the interest free period.
Till next time.