Got an increment? Invest, don't just party!

Financial advisors have identified mistakes people commonly make when they receive an increment. Spending too much on consumption and living beyond your means is the first one. Materialistic ones such as immediately upgrading gadgets such as mobile phone, car, TV, refrigerator, is the next. The final one is procrastination, such as not working on aligning your appraisal amount with your overall financial plan or postponing investment decisions for a future date.

“The common mistake that one makes after getting an increment is not increasing investments towards priorities,” says Ankur Choudhary, co-founder and CIO, Goalwise, an investment platform. This happens because in general, people (who have received an increment) don't have any financial plan.

People tend to ignore that if they do not increase their investments year on year, they may not achieve their critical goals like being able to retire with financial freedom. The money just lies dormant in a savings account.

“One needs to remember that money is one of the highest forms of energy and it is relevant only if it is nurtured well,” says Deepali Sen, a certified financial planner and founder partner of Srujan financial advisers LLP.

SMART SPEND

Wisely invest your hard-earned increment   Repay high-cost personal loans   Next, plan for home loans, emergency corpus, etc   Finally, look at retirement, SIPs, etc

Remember, nurturing means that your increment has to stay ahead of inflation and taxes (the two robbers of money) by at least a couple of notches. “Also, we have to be mindful of the fact that we can invest only when we have a surplus, and that money accumulates slowly over many years, but it may help us when we face troubles, like say a serious hospitalisation,” says Sen.

The panacea for this waste of financial resources, however, is very simple – planning.

“Financial planning is all about setting your priorities straight,” says Choudhary. Everyone has goals like an emergency fund or prepayment of loans, retirement, buying a home and financing children's education, and your increments have to match your priorities.

Calibrate your increment

“The thumb rule (for your increment) is to increase the EMIs or monthly SIP amount for your goals by at least the same percentage as that of the appraisal you have received,” says Ankur Choudhary, co-founder and CIO – Goalwise. Thus, if you got a 20% hike, increase your SIP at least by 20% to 30%cent. This also leaves some part of the hike for increasing your lifestyle expenses.

So step up your ongoing monthly investments and allocate extra earnings towards your priority goals. For instance, if you have stepped up investment in an emergency fund and reached your goal, shift on to the next priority goal in line, say prepayment of loan or retirement. This way you will be able to reach your goals sooner and get financially free faster.

While the debate between investing and repaying your loans (from your increments) will probably never be satisfactorily decided, experts are unanimous that tackling your loan is a priority.

“This is a highly subjective issue and the answer would depend on the individual's need and risk profile,” says Vaibhav Agrawal, head of research and ARQ at Angel Broking. 

Agrawal feels that any lumpsum money must be first focused on repaying high-cost loans such as a personal loan. Once the high-cost loans are repaid, the next step should be to plan your investments for short-term goals such as margin for a home loan, setting aside an exigency corpus, etc.

Finally, you must look at the long-term goals such as retirement, planning for your child's education, post-retirement fund, etc. This should ideally be done through systematic investment plans, or SIPs, on equity funds to get the benefit of wealth creation in the long run.

The interest on your loan is actually a fixed and recurring cost. Thus, the faster your loan is reduced, the more room you will have for investing your increment, points out Sen.

And if you are investing, do it wisely, don't speculate. Do not treat your increment as some 'free' money and put it in some risky investment portfolio.

Also, you can take the advice of experts.

“It is best to get in touch with your financial advisor who chalked out the financial plan for you initially,” advises Choudhary. Since your advisor is aware of your financial standing already, he would be able to revise your plan accordingly and guide you regarding tax planning and the correct investment strategy.

“First and foremost, inform your chartered accountant to revise your tax calculations and see how best you can plan your taxes for the rest of the year,” Agrawal says. Rework how you need to step up your SIPs and your insurance accordingly. Thirdly, inform your banker. “A higher income helps you to get better bargains with the bank, and you can also sit with them to consolidate your loans with a larger limit,” Agrawal says.

Your loans versus your investing

“You must apply a fundamental rule here,” says Vaibhav Agrawal, head of research and ARQ at Angel Broking. What is the after-tax yield you will get on your investments? For example, if you can earn 12% to 13% post tax on equity funds and if you can save 15% interest on your personal loan, the choice is to first close your personal loan. However, before making any long-term investment check if your home loan can be repaid. If the incremental tax benefits under Section 80C on interest are not really meaningful (it reduces with time), then you can look to repay the home loan at least partially. If tax breaks on home loans are still meaningful then continue with the home loan and look at investing your increment, says Agrawal.

But do remember the bad news. You've got more money, vis-à-vis your increment, but also on the increase is your taxes.

“However, one can minimise their tax outgo (from an increment) by smartly investing through different financial instruments available under Sec 80C or 80 CCD,” says Choudhary, adding that tax saving mutual funds (ELSS) are a popular option under 80C.

Keep your money invested always. “Keeping surplus money idle is never a good idea. Even while deciding upon an idea, deploy the surplus in a liquid MF,” says Sen.