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A monthly saving of around Rs 25,000-30,000 is a good amount, right? Well, it depends. While this can add up to over Rs 1 lakh savings per year, it should be looked at in the context of what is required for achieving your financial goals and other needs. You also need to look at the savings in the context of your expenses.
Take the case of S Vidyasagar, a senior-level manager in a multinational firm. His monthly income is about Rs 2 lakh and he is able to save about Rs 30,000 per month. This means he is spending about Rs 1.70 lakh per month, which includes Rs 46,000 as Equated Monthly Instalment (EMI) for his house and Rs 7,000 as EMI for his car. He has savings in bank fixed deposits and in equity mutual funds. Despite saving regularly, he was not happy with his corpus. He decided to consult his financial planner to see how he could improve the returns from his investments. Maybe, his advisor would suggest some new financial instruments.
Vidyasagar's predicament is not surprising considering that the equity markets have returned barely over 7 per cent in the last one year. The post-tax returns from bank FDs have also been around the same levels. But with inflation close to 10 per cent, prices of all essential commodities have been high, making it difficult for families to save money.
To his surprise, Vidyasagar's advisor told him to cut down on expenses. Money being spent on entertainment and personal expenses was about Rs 10,000 per month. The family regularly went out for dining, movies and on some weekends, they used to drive out to nearby places on daylong picnics. These and some other items were impacting the accumulation of savings. His advisor explained how despite putting aside a fairly high amount every month, the high inflation and volatile equity markets were impacting the returns. The only way to improve this was by cutting expenses.
Many families face this problem where expenses completely overwhelm future planning itself, cutting off funds needed for a well-funded future. In such cases it is advisable to tone down expenses. Incidentally, Vidyasagar and his family were able to tighten their belt and release another Rs 15,000 towards savings.
Calculate your savings-to-expenses ratio
Savings need to be seen in the context of one's spends. You need to calculate what percentage of your expenses can be covered by your savings. In fact, 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 money being saved will cover 75 per cent of the expenses for a month. In Vidyasagar's case, his saving of Rs 30,000 can cover only 26 per cent of expenses without EMI (Rs 1.17 lakh) and under 18 per cent of expenses including EMI (Rs 1.70 lakh). The savings-to-expenses ratio, shows the even though both are saving the same amount, the former is better off than Vidyasagar. Hence, this ratio is an important indicator of how someone is managing their finances. A high ratio is good and would indicate that savings are healthy enough. While regular expenses may not pose problems, a low ratio could have an impact on future goals.
Goals are future expenses
Some families have very 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.
Know your expenses
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 your were to spend the entire balance amount, it would be only after putting aside the required savings amount.
The second aspect is to seriously look at expenses. 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 is necessary to tailor the necessary course correction.
Account for 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 (CPI) inflation 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 to first understand how much you are spending, what you are spending on and whether it is possible to pare it down, what your future goals are, whether the goals are realistic and whether you are saving enough in relation to the expenses. Also, you need to understand the impact of inflation on your savings. So, expenses are an area which you need to look at carefully more than even savings - for that can make or mar your future.
SAVE MORE EFFECTIVELY
* Many families face this problem where expenses completely overwhelm future planning itself, cutting off funds needed for a well-funded future
* In such cases it is advisable to tone down expenses and release more money towards savings
* Savings need to be seen in the context of one's spends. You need to calculate what percentage of your expenses can be covered by your savings. In fact, even low level of savings can work if the expenses are in check
* The savings-to-expenses ratio is an important indicator of how someone is managing their finances.
* A high ratio is good and would indicate that savings are healthy enough. While regular expenses may not pose problems, a low ratio could have an impact on future goals
* 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
* It is important to first understand how much you are spending, what you are spending on and whether it is possible to pare it down, what your future goals are, whether the goals are realistic and whether you are saving enough in relation to the expenses
The author is founder, Ladder7 Financial Advisors
