Few days back, I received a very interesting email, snippet is as follows “…. I am developing a keen interest in your dividend investing philosophy. The more I read the more I get excited about. The earlier one starts, the better it is and I want to start now……. I am 24 years old and have a full time job for last two years. The earlier I start the better it will be for dividend investing. Can you advise 5 companies where I can invest and forget them…..”.
After exchanging few emails I observed his (I don’t know whether it was his or her, for the sake of this post I will use “his”) parents had taken a low six figure educational loan for him to complete this MBA education. After he started working, in his quest to quickly earn few bucks, he started investing in equity markets and is now under water. Now this reader wants to put his financial house in order.
On a personal note, I have gone through the student debt phase. I can very well understand what it means to be under student loan debt.
I am not a personal finance advisor. So I could not give him any specific advice per se. However, I shared my personal experience and discussed with him a very high level frame which I had followed. This discussion was not directly related to dividend investing. But I think it followed the essence of dividends investing (i.e. strong foundation and small building blocks). I thought of sharing this framework with readers of my blog.
At an outset, I was impressed by his sincere effort to put his financial house in order. I believe realizing the mistake and desire to correct it is like winning half the battle. Without much ado, here are steps that I had followed.
(1) Assess state-of-finance: After you get your first job, assess you finance with reference to “incoming cash flow” and “outgoing cash flow”. Once these two factors are mapped out then it is time to figure out how to optimize both sides (i.e. maximize incoming, and minimize outgoing). For the first two years after graduation, debt elimination or reduction should be the primary goal.
(2) Emergency funding: Before you start planning and fantasying of dong anything with your money, build a buffer of emergency funding. Instead of buying a big ticket item or to begin investing, create an emergency funding for self. Depending on your own situation (such expenses and comfort factor) create a cash buffer of Rs. 50000 to Rs. 100,000. Rule of thumb is this buffer should be for at least 6 months of livings expenses. Keep it invested in high interest savings or CD accounts. It can be done over a period of time based your personal situation. The best way is to use recurring deduction from your salary account. The faster you accumulate, the faster you will have additional cash at your disposal for other tasks.
(3) Debt reduction: After emergency funding, this is next big ticket item that you need to worry about. Identify a solution for this. You may think that it is a small amount and your outgoing cash flow analysis may not make it obvious (or significant). However, it is drain on outgoing cash flow, like water continuously dripping out of a water bottle. Since it remains for a long time it just takes forever. My personal opinion is, if possible, discuss with your friend and/or family member (with whom you can), and borrow small amounts to immediately reduce your principal amount. Over a long term, it has a significant impact. This not only reduces your monthly payments, but also the overall interest that one would pay over a period of time. Just avoid any additional loans for first two or three years after you start working. Just focus on building a strong financial foundation.
(4) Share apartment: Hey what’s wrong with this one? Didn’t you do in college for four years? Why not for additional one or two years? This helps in reducing outgoing cash flow.
(5) Part time money making activities: This is where I believe most new full time workers miss the bus. Being out of college and money in their pocket makes them loose focus. I believe if one can spend some extra time in part time jobs they can increase their incoming cash flow. This in turn can be used for debt reduction.
I believe for the first two years of your professional working life, one should focus singularly focus on debt reduction and/or laying your future financial foundation (and not investing in stock markets). At most, investing can be done under the umbrella of your PPF accounts at your work place.
When the combination of emergency buffer and/or debt level has been reduced by 80% or more, then one should start thinking about investing strategies. Not having a emergency funds and debt on your head, will always remain a week link in your foundation. These few things may seem trivial, but two or three years down the line, it can help lay a strong foundation. I believe it is very important to have a strong foundation and then use small building blocks to construct your majestic financial empire state building.
In next post tomorrow, I will share my top three investing mistakes.
beginners guide, investing, personal finance