ARTICLES

Spending, Saving, and Investing

When people start earning in India, they face a big question. A question that decides the quality of their life: “What do I do with this amount of money?”

For a lot of people, money is nothing but a medium of exchange. They start spending money immediately on things they dreamt about; experiencing the most expensive restaurant of their city, purchasing the latest iPhone, which they have always wanted. Some even buy a big thing like a car or a house on EMI, which makes them feel proud.

One of the most important things that people do not consider is “what would I do if there are some sort of unforeseen circumstances?” Isn’t it true that a lot of people are laid off every month in our country?

Just imagine you buy a house with an EMI of 40k per month for 8 years with a salary of 1.5 lac per month. You think you can pay the EMI comfortably and enjoy your big house. And then the recession arrives, you lose your job and your only source of income. You just have savings for the survival of 6 months. Now the question is, what will you do in such a situation?

Here comes the Idea of financial health. What most people do not understand is how to allocate their earnings to the 3 crucial aspects of financial health: spending, savings, and investment. We will discuss this in this article.

While it is true that we earn money to fulfil our dreams, to buy the expensive things we have always wanted, we also want our money to act as a lifesaver in times of adversity.  

When we are young, we do not have a lot of responsibilities, but as we age, responsibilities increase, and we need more money to cover them. Therefore, we are taught that we should save a portion of our earnings for the future. But is saving money enough? Unfortunately, no, since inflation keeps decreasing the value of our money kept in the bank. Therefore, it is quite necessary to invest the money in a useful asset that helps our money grow over time.

Common Myths:

“I am too young to invest”:

Many people, when they start earning at a young age(early 20s), think that they are too young to invest and have a lot of time to start the journey of investing.

While it’s true that we are supposed to spend our earnings to fulfil our wishes, even if we invest a small portion of our salary regularly, we can earn great returns for the long term.

Consider the following example:

Rahul, a 22-year-old guy, earns 50k per month and manages to invest 5000 per month regularly in an index fund that provides 13% CAGR*. Can you guess the value of his investment when he is 42 years old? He will have a corpus of more than 56 lacs (As per the SEBI calculator). At the age of 62 years, he will have a retirement fund of more than 8 crores

Yash, another guy, starts investing a greater amount of 8000 at the age of 30. At the age of 42, his corpus has a value of almost 27.46 lacs. At the age of 62, he has a retirement fund of 4.55 crores 

Even after investing more than Rahul, Yash could not match the total corpus size of Rahul.

This is the power of compounding. The earlier you start, the higher the benefits of compounding you can enjoy. Most of the people do not understand this.

“I must understand everything before investing”:

A lot of people think that they need to become an expert before starting to invest, and end up delaying investing for a long time. Although it is true that you need to do some basic research before investing, but you do not need to be an expert to start investing. Simple investment options like Mutual Funds are a good way to start the process of investing. You can take help from an expert like a financial advisor, who can guide you about where to invest and how much, however the advisor should be a SEBI-registered person/entity.

”I need a lot of money to start”

This is a major misconception among people. They think that they need a lot of money to start investing and keep on procrastinating the process. In the above example, we saw how a simple investment technique that involved 5000 rupees generated returns when kept for a long period of time. People should understand that they can start with any basic amount of money that they can afford to save every month(after covering the necessary needs in life) and keep that habit alive for a long horizon in order to reap the benefits of compounding.

Investing is Different For Everyone:

You must have heard financial gurus on the internet talking about different rules, like the 50:30:20 rule. But do we all have the same financial condition? No, right? Then how can we all allocate our earnings in the same manner? Consider the following 2 examples:

Rahul, a 22-year-old boy who has just got a job of 50k, has strong financial support from his parents. He wants to build a good fortune for his future generations through his own money. He decides to spend 50% of the money, invest 45%, and save just 5%. 

Yash, another 22-year-old guy, has had the same job for 50k. But his parents don’t have the money to support him if he runs out of it.  Can he do the same thing as Rahul? Can he keep just 5% person of his earnings in the bank, while spending and investing the rest of it? No, right? 

Then why do we think we all can have the same financial formula, while we all have different financial conditions? We have to understand that there is no single formula for the allocation of money; it depends on our financial condition and our goals.

Factors Deciding Allocation:

Current Financial Status:

This includes the debt status and the family's financial status of the person. 

(a) Debt: If the person has a large amount of debt with a high interest rate, then a significant portion of the earnings should be used to repay that debt while keeping the investing portion relatively lower. If the person has a small/manageable amount of debt with a low interest rate, then he can consider investing a large portion of the earnings while paying back the debt at a slower pace.

(b) Family's financial status: If the financial status of the family is not so good, then the person should consider keeping the savings portion higher and the investing portion as affordable. This is done so that in times of unforeseen circumstances, there is enough money in the bank for his/her monthly expenses. 

On the contrary, if the financial status of the family is good enough and the person can get help from his/her family in times of emergencies, then he/she can consider investing a larger portion of his/her salary while keeping the savings low so that a higher return can be earned on that money in order to upgrade the lifestyle.

Age:

Allocation of the earnings into investing, savings and spending is different for different age groups

(a) Young adults(18-29): People belonging to this age group can consider investing a larger amount of their earnings because they can take higher risks due to their young age and less responsibilities. They can take risks while investing. Investing in this age yields maximum compounding benefits, which should be utilised as much as possible.

(b) Middle Aged Adults(30-50): People belonging to this age group usually have a lot of responsibilities to fulfil, and hence they have to save a large portion of their earnings to support their family, the education of their children, etc. The aim should be to keep a good amount of savings while investing a respectable amount of money regularly for the future.

(c) Older Adults: People belonging to this age have to preserve their capital for their retirement. They should save a major portion of their earnings and invest the rest of their earnings in fixed-income generating assets.

Income Level:

(a) Below Average level: Say, if the person is earning less than 50k in a tier 1 city. A major part of the salary will go to survival expenses like rent, food, etc. The goal here should be to invest a small amount (such as 10-15% of the salary) regularly while maintaining an emergency fund for unforeseen circumstances. 

(b) Average Level: Say, if the person is earning around 50k-1lac per month in a tier 1 city. Now the person here has the option to either upgrade his lifestyle aggressively by using all of his income or gradually improve his lifestyle while investing a higher portion of his salary. Emergency funds should be maintained here as well by saving regularly.

(c) Above Average Level: Say, if the person is earning more than 1 lac per month. In this case, one has a lot of money, which should be used to invest, while simultaneously upgrading one’s lifestyle. Around 30-50% of the earnings can be used to invest in various assets. Emergency funds should be maintained here as well.

FINAL THOUGHTS:

There is no universal formula that tells everyone how much to allocate to each of the 3 domains. One should understand his/her own circumstances and then build a system that balances present needs with future security.

In the end, financial health is not about following a perfect formula- it is about making sensible decisions with money and staying consistent with it over time. However, as the financial health of the person changes with time, one should also learn to change his pattern of dealing with money over time.

*Disclaimer: Investment in securities and other investment products is subject to market risks. Read all the related terms and documents carefully before investing.

Note: The above content reflects personal views and is intended for general informational purposes only. It may not be applicable to all individuals and should be adapted based on personal financial circumstances.