18 July, 2015

Are you rich or poor?

Your financial adviser may differ with your perspective.

Someone who has over Rs 5 crores of investments can be called rich. That’s my opinion. A wealth manager may disagree and believe the individual is mass-affluent, not rich. According to some of them, the rich category starts at Rs 25 crores or somewhere in that vicinity. The “really rich fold” would have salted away Rs 100 crores or more. The super-rich club would start somewhere at Rs 1,000 crores or so.

If you were to ask the man on the street – the aam aadmi (not to be confused with the party that professes to represent him), he would probably call most of us rich. Why?

Simply because we have our dwellings, gad around in our vehicles, send our children to decent enough schools, take vacations… to them, it seems like we are living it up!

Now ask yourself: Are you rich?

The most common reply would be: Not me; no way! I’m just a middle class guy.

Also Read: Lifestyle expenses can wreck important goals

This middle class, however, is a super-elastic bracket which takes within its ambit someone who earns Rs 15,000 to Rs 1 crore a month! Hence we have terms like lower-middle class, middle-middle class, upper-middle class and upper class! People want to believe they are in upper-middle class or at least middle-middle class – else they will feel miserable and poor!

If you were to ask our government, they would call everyone earning more than Rs 30 a day as middle class.  If you are paying taxes, you must be rich – that’s why they are taxing you, remember?

You would then agree that defining who is rich is really confounding, right? It is. But we have come up with a different methodology for identifying the rich. In our methodology, even how much one earns or has does not matter. What matters is the staying power. I might have confused more than I have clarified, but stay with me.

As financial planners/ advisers we come across people from various walks of life, earning piffling sums to the motherlode pay cheque. Spends are different too – for some they are modest and for others it reaches the stratosphere!  When there is so much variance, how can we come up with a reasonable definition of who can be classified as rich?

Let’s first understand what does not classify a person as rich.

For starters, multiple cars, a home with all the trappings of luxury and the latest gadgets, children enrolled in expensive private schools, regular family vacations, and high-paying jobs do not mark out a person as rich. Even multiple properties and a seemingly good cash-stash does not.

There are a few markers which would help us separate the ones with pelf from others who have small change, in a manner of speaking.

  • Spend ratio
If someone is spending over 70% of their income, they may be spending too much. This would be true for virtually any income band. Would be truer for those who do not have too many years to retirement. They should be saving more, in fact.

For instance, a person at 50 would potentially have another 10 years to retirement. His income would be pretty good, at that point. Expenses should have plateaued. If loans are still there, the EMIs as a percentage of earnings should be a meager number. College education may be underway for the children – but money for that would have been squirrelled away separately. So, they should be saving at least 40-50% of their income, if not more.

This is going to mark out the rich from the poor. Those saving too little during their earning years are setting themselves up for penury, in the years ahead – however grand their present looks!

  • Expenses
It is rarely the grocery or regular home expense that spells trouble for most. It is the discretionary lifestyle expense that breaks the piggy bank. Many of them have a busload of goals that guzzle cash –second homes, foreign vacations, multiple cars with frequent changes, child’s education abroad, etc.  This ensures that much of their earning goes towards servicing loans over a long period.

A very high watermark for expenses is a red flag. Family members get comfortable with a high-flying lifestyle. And they keep upgrading it. Expenses hence tend to be high throughout and savings commensurately lower.

The corpus would hence be small at retirement. With expense high and a low corpus, they could support themselves only for a few years after retirement.  They may have to cut their lifestyle drastically, just to survive, making them decidedly poor.

  • Big corpus myth
Many clients think that they have a big enough corpus and will be able to sail through retirement, easily enough. A seemingly big corpus is no guarantee for a fully funded, comfortable retirement. Inflation and medical expense nibble away at the corpus. Also, increased longevity can deplete even a gargantuan corpus.

Penny pinching – a preserve of the poor – will then have to take centrestage.

  • Cash flow
A good salary and strong cash flow in the bank lulls people into a false sense of security. People tend to take it for granted that life will always be like that – getting their jolt when the pay cheque stops. That is when they start experiencing the privations of the poor!

So when is a person rich?

To summarise, one’s earnings or corpus does not make a person rich. A blizzard of expenses and a false sense of security can actually make one poor.

A person is rich when there is enough money for various needs – now and in future, and when one does not need more nor is craving for more. They are the ones who can be at peace and live a contented life. Sounds philosophical, but true. The rest are poor and they need to think hard about it – for their own good!

The article was published in Morningstar.in on 2nd July’15

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