10 February, 2014

Why you need to focus on your spending for your financial wellness?

A friend of mine was elated that he was saving Rs.25,000 a month.  He swelled with pride at being able to put aside a quarter of a lakh towards savings.  But somehow, when I ran the numbers to find if he can achieve his goals, they showed that he is woefully short of the amounts required.

It is infact true that Rs.25,000 savings per month is a good figure. But this has to be looked at within the context of what is needed for achieving the goals and fulfilling other needs. Also, one needs to look at the savings in the context of one’s expenses. 

Expansive Expenses are a problem :  In our practice, we find lots of cases where expenses are the undoing element in the plan.  Our client Vidyasagar, is a senior level manager in a multinational firm. He earns about Rs.2 Lakhs as income and he is indeed able to save about Rs.30,000 pm.  This means he is spending about Rs.1.7 Lakhs pm., which includes Rs.46,000 as EMI for his home and another Rs.7,000 as EMI for the car. This still means that he is spending Rs.1.17 Lakhs pm.

We found this to be high and went through various items of expenditure. We found the expenses in some items like entertainment & personal expenses to be pretty high at about Rs.10,000 each. On further discussion, it emerged that they do go out for dining, movies and on some weekends, they drive out to nearby places on a daylong picnic. Similarly, the personal expenses included his wife Bhanu’s parlour & her personal expenses as well as some personal expenses of Vidyasagar. We found some other items as well which were high, which were impacting the buildup of savings.

Normally, we do not overstep our limit when doing financial planning for our clients. Our philosophy has been that the clients should be allowed to lead the lives that they choose, rather than we standing in judgement on what they could do. But, we have found that in some cases expenses completely overwhelm future planning itself, cutting off the funds desperately needed for a well-funded future. It is in such cases that we point out the problems encountered in building the required corpus and get them to tone down their expenses, for their own sake. Incidentally, Vidyasagar was able to tighten the belt and release another Rs.15,000 towards savings.

The ratio that that mirrors your health :  Savings per se is not something that can be termed high or low.  Savings need to be seen in the context of one’s spends. Infact, even low level of savings can work if the expenses are in check. For instance someone spending Rs.40,000 a month and saving Rs.30,000 a month is actually doing quite well.  That is because the saving being done will cover 75% of the expenses for a month. In Vidyasagar’s case discussed before, his saving of Rs.30,000 can cover only 26% of expenses without EMI and under 18% of expenses including EMI. This measure shows the even though both are saving the same amount, the former is better off than Vidyasagar.

Savings to Expense ratio is hence a very important indicator of how well someone is managing their finances. A high ratio is good and would indicate that their savings are healthy enough.  But, the regular expenses may not pose problems for some, but the future goals can.

Some have pretty ambitious goals. For instance, some parents want a lavish wedding for their children which would be an expensive proposition. Goals are future expenses. If these future expenses are very high then the savings required in the run up to the goal will also be high. It is hence important to do a reality check on the future goals too and see if they are in line with what one can reasonably expect to save.

Spending Ignorance is not bliss :  Many do not really know what they are spending.  And that could be a big problem. Since they earn a good amount, they keep withdrawing money from time to time, till the money gets exhausted.  This problem needs to be tackled in two ways. Estimate the amount of savings required and put that away before starting to spend. That way even if they were to spend the entire balance amount, they would have done that only after putting aside the required savings amount.

The second aspect is to really seriously look at the expenses themselves. Unwittingly, one may be overspending in some areas. Only when they get down to it and calculate how much they are spending would they become aware of the problem. This knowledge is necessary to tailor the necessary course correction.

Havoc of Inflation :  The other problem faced by people today is inflation. Expenses are ballooning even though they are essentially consuming what they used to consume before.  Consumer Price index has been in double digits in three out of five years, since 2009. But investments have not kept pace. The investment returns post-tax, are lower than the inflation figures, which means that one needs to spend much more for the same value. This is even more reason to be aware about one’s expenses and see how to keep it in check.

It is important for people to hence first understand what they are spending, what they are spending on and whether it is possible to pare it down, what their future goals are and whether they are realistic & whether they are saving enough in relation to the expenses . Also, they need to understand the inflation monster and it’s pernicious effect on them. So, while planning ones finances expenses are an area which one needs to looked at carefully more than even savings – for that can make or mar one’s future. 

Author - Suresh Sadagopan  ;       A version of this was published in Business Standard on 9/2/14

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