SMART MONEY | A PLAN FOR YOUR LIFESTYLE
Afew decades ago, a side hustle mostly meant one was saving up for a big expense like buying a car or that home theatre which was so appealing. Today, a side hustle is all about ending a month without going hungry or a delay in paying out rent. It was easy to save money from the salary, even if it was little, today if you ask someone from among the GenZ about saving money, they would stare in disbelief. It is not that they aren't trying, money just doesn't seem to be enough today. Rising living costs, economic uncertainty and jobs are all causes of concern when managing one's finances.
Traditional personal finance adviceâsave 10 per cent of your income, don't spend over 40-45 per cent of your income on rent and household expenses or don't pay EMIs of over 25-30 per cent of your incomeâare all statements that sound good in theory, but the way we deal with money these days is different and complicated. Consumer spending is on the rise, unemployment is on the rise and income levels aren't going up fast enough for financial goals to be easily achievable. Personal finance is changing and you need to adapt to knowing the old ways while factoring in the new.
It is appealing for one to go pick that new phone available on EMI rather than wait for months to save up for it. Chances are that the model you saved up for is being phased out and a newer one is more useful. For a youngster, it is more important to have the new gadget now than delay the decision to own it later. Their mindset is different and it is not always to keep up with others. As phones have become essential and their usage a lot more complex than using them for a voice call, they may have professional benefits forcing one to change the phone frequently.
Similarly, the traditional advice to save up to six months of household income towards emergencies fell flat during the pandemic years from 2020. The changing circumstances meant one actually required a lot more money than a few months' household income. Many also faced a situation of lesser pay or job loss, yet often their expenses continued to go up. What we are looking at now is a situation where traditional financial planning at best could be a reference point, but it needs to consider changing lifestyle needs. For instance, retirement at 60 years for a 20-something is far too away to imagine and work on.
Navigating complexities
There is a general feeling among most salaried people that they aren't earning enough to meet their financial needs and aspirations. While everyone's financial circumstances are different, the reasons why our salaries are just not enough, regardless of how much we earn, are either because the salary is small or expenses are constantly on the rise. Let's face it, the traditional household budgets are difficult to adopt not because it is complex, but because expenses aren't steady anymore. For instance, your grocery bills aren't the same month after month and it is not because you are consuming more, it is because prices are changing far too often.
To hoodwink consumers, many packaged groceries are adopting a shrinking pack-size trick by maintaining the price, but reducing the quantity in the packaging. This is shrinkflation, a concept of making you believe that you aren't paying more, but in reality, you get a lot less for the same price over time. Likewise, the 50/30/20 budget rule which states that you should spend up to 50 per cent of your post-tax income on needs and obligations, 20 per cent to service loans and use the rest the way you want is no more practical.
Moreover, inflation is well understood today when working on financial plans because its impact is felt strongly on not just expenses, but also savings and investments. We have come a long way from a thumb rule of taking life insurance cover of 10 times our annual income to using calculations that factor in financial goals, existing insurance and other financial needs that may arise when taking an insurance cover. Financial advice is no more general, it is specific and has more to do with personal than finance. The four pillars of financial planningâassets, debts, income and expensesâare getting complex.
For instance, today when you are servicing a home loan, you also have the convenience to borrow a percentage against the money you have repaid on the loan. Basically, an asset which you don't fully own could also be used as collateral to borrow against. Likewise, spending through an app or card often refunds you in the form of cashback, which is nothing but indirectly creating income on expenses. These are some examples of how complex financial planning can become. The influence of technology in financial advice is making financial advice accessible, but with access also comes the difficulty of being disciplined. For instance, every time one sees the worth of their investments rise, they tend to cash it to satisfy a financial wish. Technology is also creating a web of complex financial solutions which are difficult to understand. Take for instance a simple UPI (Unified Payments Interface)payment, it is convenient, fast and less stressful than carrying cash. Now imagine if you used the UPI 10 times a day at various places, it is not a straightforward tracking history about which merchant you paid for what service or product. You have to check the UPI tracking number to know what you spent on. The convenience of a wallet on you comes with the responsibility to control your spending.DIY financial advice is another aspect which offers you the option to manage your finances on your own. However, not all of us are capable of handlingfinancial decisions such as investing or borrowing on our own.
Dynamic financial planning
The belief that financial planning is all about creating an emergency fund, taking life and health insurance, planning for retirement and estate planning is wrong. These are all just contours of financial planning. It is no more about compartmentalising saving, spending, investing and protection. Financial planning is all about how each financial decision you make impacts your overall financial goals. Think of the impact of contributing Rs 5,000 less to repay the EMI or investing the sum on a goal and its impact on your finances.
Think about an evolving financial life which includes your financial stages such as changing careers, raising a family and changing circumstances in life which your financial plan needs to adjust to. While traditional financial planning also factors in stages of life, it sets a blueprint for you to follow at each stage. For instance, a family of two kids with the possibility of parents staying together calls for having a 3-4 bedroom house to manage the multi-generational home. However, as children start moving out, chances are the need for the house reduces to two bedrooms.
In the above example, one could actually own a 2-bedroom house while living in a 4-bedroom house paying rent, because that works well. Now, if one were to buy a 4-bedroom house to manage 15-20 years of their life, the higher cost for it would impact other financial goals and needs. Dynamic financial planning is about aligning finances to your values and changing life that ensures financial decisions are personally fulfilling and not following a textbook principle.
An aspect of traditional planning which has provided confidence to people that they can achieve their financial aspirations is goal-based financial planning. Goal-based planning is the process of helping you prioritise your financial goals and work out an optimal plan to fund it. For instance, your goal is to have Rs 20 lakh 10 years from now, when your eight-year-old son will enter college. To achieve this goal, you need to invest Rs 13,100 each month in a financial instrument earning 10 per cent returns. Generally, such an instrument tends to be a mutual fund, because mutual funds offer the convenience to invest each month regularly.
This encourages you to list all your financial goals and put them in a matrix considering the money you need and the time frame for it, with an assumed rate of return. There are numerous online resources and calculators which will throw up how much you need to invest each month to realise all these goals. It is a wonderful approach to break down your financial goals into a small regular investment. Imagine the ease of investing towards your retirement, children's education and accumulating funds for the down payment of a house all at the same time being convenient.
Mutual funds have done their bit in popularising goal-based investing, which has made accumulating any amount of money theoretically possible. There are tools specifically aimed at accumulating a crore, which is achievable if you start investing early (see The crorepati fixation) and continue to do so for long periods. Mutual funds allow you to make monthly investments through SIPs (systematic investment plans) which make reaching financial goals achievable. You can choose the type of fund you are comfortable with based on your risk appetite and ability to make SIP contributions.
With the goal-based investment approach, you have a roadmap for achieving specific financial outcomes rather than simply accumulating wealth. These days, goal-based calculators factor in inflation and encourage you to dynamically change your goals and contributions. Your unique circumstances and objectives such as age and risk profile are factored in to tailor the investment product to match closest to your needs. You can track the progress made on the accumulation front for each goal and modify it accordingly. For instance, if you are falling short a little on one goal, you could contribute more to it, while temporarily reducing the contribution to a goal where you have more time.
Loan to bridge the gap
Traditional financial advice encourages borrowing to buy a house or fund education. These two loans fall under the asset-creating category because the value of a house is likely to go up in future and education can help you increase your income generation. From being that excellent financial tool for people who needed products and services now but didn't have the money for them, loans have become an easy way out. However, remember that every loan comes at a costârepayment with interest through EMIs (equated monthly instalments).
Such is the influence of loans in one's life that it is rare to find someone not servicing a loan of some kind. Loans can play an essential role in financial planning in several ways, especially in financing large purchases like buying a house, which is otherwise almost impossible to achieve these days. You could also use credit to bridge the gap in your financial goals. For example, if you fall short on funds when purchasing a car, you could borrow the shortfall and buy that car. The same goes for funding a vacation or buying a gadget.
Buy Now, Pay Later (BNPL) as a concept and a loan product has become the most in-demand financing option to pay for groceries to existing loan repayments. This facility is used mostly by youngsters who fall short of money towards the end of the month to pay for products and services which they cannot do without. These are very short-term loans that bridge the financial shortfall until one receives their next pay.
There is another advantage of borrowing money; it leaves a credit trail which helps you manage your cash flows and, when needed, leverage your assets. But, taking too much debt can also harm your financial future.
If you are impatient and someone who can't wait to save and then realise a financial goal, a loan is a smart way to achieve your financial goal. A loan in general is not bad as long as you get something out of it financially or otherwise. However, be careful when servicing loans, because defaults and delays are expensive and could leave an unfavourable mark on your credit score impacting the possibility of borrowing when you may really need it.
Financial decisions
Your lifestyle choices are a reflection of your values, priorities and aspirations. Whether you prioritise travel, education or philanthropy, the choices have financial implications. For instance, if you value experiences over material possessions, your spending and saving patterns will reflect that. A traditional financial plan might prioritise saving for a home or retirement. In contrast, a lifestyle-based plan would incorporate ways to fund your wishes while also securing your financial future. In the above example, you are more likely to live on rent than owning a house. You may also be less possessive of materialistic things and all such habits and behaviour have financial implications.
As life expectancy rises, so does the need for active engagement with your financial plans. Relying solely on savings or investments may not be enough. You will need to extend your working life to as long as possible and keep abreast with the changing financial landscape. It is not just financial instruments that you will need to know about, you should also learn about concepts that would help you form a guideline that you could use to stay on top of your financial life. Keep customising your investments to align with your unique financial goals and risk tolerance for long-term success.
One does fear the unknown when it comes to personal finance. The fear of losing money while investing or worrying over making a wrong financial choice or the fear of missing out on wealth creation opportunities makes many avoid taking any decision. Handling money is an emotional task and at Smart Money, we believe in empowering you to make informed financial decisions based on knowledge and understanding rather than succumbing to fear. And there are ways to manage it on your own or seek the help of those who do it for a fee.
Yes, there are several aspects around financial planning and plenty of financial products, financial jargon, rules and regulations that one needs to know. But the best way to reach your financial objectives is to work on a plan, which would give you a certain degree of discipline and allow you to utilise your income more optimally. Think of managing your finances as any other big moment in your lifeâcracking a competitive exam, planning a movie with friends or a family vacation and so on. Managing money smartly follows the same logic; you need a plan to start.
To see essential personal finance needs in a simple manner, you could read the financial advice given by Scott Adams, the creator of the Dilbert cartoon character. In fact, so profound is this less-than-a-page (see Everything you need to know of personal investing) advice that it addresses 95 per cent of an American's financial needs. If one were to switch the IRA (Individual Retirement Account) and 401K with PF (provident fund) and NPS (National Pension System) in India, the advice given by Adams would apply to every Indian income taxpayer.
Yet, knowingly or unknowingly we all complicate our financial lives with many bank accounts and linked debit cards, take on numerous insurance policies without analysing how they work or put money into investments which may be too risky for us and so on. One of the reasons for complicating financial lives is the lack of understanding and seeking excitement with our finances. Smart money moves take time and patience and is boring, because it is so focused, sticking to a plan and being consistent. Moreover, it is all about working on future financial needs, while you give up on some things that you may wish for at this instant.
Remember, implementing your financial plan is not the end; it's just the beginning. Make ongoing adjustments to your financial plans and journey because life is dynamic and full of surprises to scuttle even the best-laid plans. You need to assess your investments, change in tax rules and your own targets to stay relevant. For instance, if you are going through a financially challenging period, you might need to renegotiate loan terms or consolidate debts to manage your liabilities better. These adjustments ensure that your financial plan remains aligned with your evolving life circumstances.
Lastly, think of financial planning as a long-distance train journeyâyou know the start and you know the end; the in-between can pose challenges you haven't planned. Be prepared to face the challenges by being informed. With financial systems drastically shifting, you can keep evolving with time to get the best out of your money.
The Crorepati Fixation
A dream that many Indians live with is to become a crorepati. Such was the fascination for this figure that the British TV game show, Who Wants to Be a Millionaire? was made into Kaun Banega Crorepati (KBC) in India to play on the magic figure. The iconic show has made the figure of a crore seem achievable and now many people wish to know what it will take for them to become a crorepati, even as many others wish to know if a crore is a good sum to retire with. Yes, Rs 1 crore is a big amount, especially when many of us are barely able to save a few thousands each month.
But, with discipline and risk-taking, achieving a corpus of a crore is within reach. Let us take the case of 30-year-old Rakesh, who wishes to accumulate Rs 1 crore by the time he is 50 years old. He could easily reach this target by investing Rs 13,060 each month for the next 20 years in an instrument earning 10 per cent returns. Now, if Rakesh had started to work on this target five years earlier, he would have needed Rs 7,474 each month, earning the same returns. A delay of just five years nearly doubles what he should save each month now.
Likewise, if he had delayed to start saving for this target by five years, he would need Rs 23,927 each month (see Target Rs 1 crore). The essence of this example illustrates the need and advantage to start saving early to reach a desired financial goal. So, Rs 31.3 lakh invested over two decades becomes Rs 1 crore. However, these figures don't factor in inflation. If we assume an inflation of 5 per cent, to reach the target in 20 years, Rakesh would need to invest Rs 24,906 each month, which is a rise of Rs 11,846 each month or an additional Rs 28.43 lakh over the two decades.
The impact of inflation should be understood with the fact that what Rs 1 crore is today is not going to be the same 10 or 20 years from now. Going with the same example: suppose Rakesh has Rs 1 crore with him today, its worth would be Rs 35.8 lakh when he turns 50 and just Rs 12.85 lakh when he is 70 years old (see Value of Rs 1 crore over time). The drop in value of a crore over time is not to scare you, but for you to understand that the impact of inflation eats into your wealth. You need to set a much bigger target for wealth creation than settle for just a crore, which today seems a good sum, but may not be enough a couple of decades from now.
Another way to factor in inflation is to understand its impact on your monthly household expenses. Suppose, your monthly household expenses today are Rs 50,000, with 5 per cent inflation, this figure will be Rs 1.32 lakh in 20 years when you turn 50 (see Impact of inflation on monthly household expenses of Rs 50,000). So, asmuch as Rs 1 crore seems a big as well as achievable target to save for, it is not a constant figure. Those aspiring to have Rs 1 crore with a few decades ahead of them should aim for a higher target.
Likewise, those having this sum right now and considering retirement need to rethink if they are in their 40s and early 50s because, with increasing longevity, this sum will not be enough for them as their withdrawal from this corpus may increase or their risk appetite would go down and the corpus may just about match inflation. For instance, if Rakesh has Rs 1 crore today and considers retiring, this money at Rs 50,000 monthly expenses would last him just 12 years.
So, even those who are closer to retirement and with a crore with them need to think about this figure just not being enough to last their retired life of 20 years or more. Suddenly, it seems that a crore is just not enough. It becomes important for one to start early with saving and investing to build the first crore and then continue the boring habit of regular investing to boost this target. While it looks very easy to accumulate a crore, it needs discipline.
For instance, by investing Rs 10,000 through an SIP and earning a 10 per cent return for 30 years, you will accumulate Rs 2.27 crore. But, if you delay this process by even a year, your accumulation will be dented by Rs 22 lakh and add up to Rs 2.05 crore. A five-year delay could shave off your corpus by Rs 95 lakh, which is a big sum to lose out over a late start. You need to realise the impact of the power of compounding and the advantage of SIPs to accumulate a target, but not at the expense of losing out on the opportunity due to a late start.
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