Power Point
The two questions that help manage your money well
- Find out the answers to how much ‘should’ I invest and how much ‘can’ I invest
People often fail to realize that money management is all about some very basic fundamentals. And where it concerns investments, we first need to ask two fundamental questions: the first is how much ‘can’ we invest? and the second, how much ‘should’ we invest? Both questions may sound similar, but the answers can go in completely different directions. Let’s first explore the answers.
How much ‘can’ we invest is a function of two parameters: Income and expenses. Now we all know how difficult it is to control Income. We all want it to be as high as possible. Eventually, it's something where we have very limited control. Expense is where we can exercise control and unfortunately we either struggle doing it or fail completely.
I will segregate my expenses into two broad categories—discretionary and non-discretionary. Typical examples of discretionary expenditure are clothing, eating out, movies, etc. These expenses are not necessary for survival but reflect your lifestyle. Non discretionary expenses are rent, electricity, salaries for maids, grocery, toiletries, etc. The struggle that people face is to control their discretionary expenses. The first step is to budget for them once you have compiled your non-discretionary ones. So, let’s say you have a salary of ₹1.5 lakh per month and your non-discretionary expenses come out to be ₹70,000 per month. So you have a scope of ₹80,000 per month for discretionary expenses. So, is that the amount that you can spend on movies, dining out, etc. The answer is No.
Your disposable income is ₹80,000, income that you can spend without having to worry about your survival. Many among us just do that, spending it on discretionary items. Smarter people recognise that it is the sum of their investible surplus and discretionary expenses. Like smarter people in every domain , they do things differently in deciding about their disposable income also. So, instead of defining their discretionary spend first, they define their investable income first and then decide how much to spend at the movies, restaurants, etc.
Thus, your income becomes a sum of three components: Discretionary spends, non-discretionary spends and investible surplus. Now how will you decide what amount should be your investible surplus ? That brings us to our second question: How much ‘should’ one invest?
For this, we must first define our financial goals, the most common being retirement planning. Then we have goals like children’s education, their marriage, buying a dream home, a big car etc. Except for retirement planning which is more about generating regular cash flows, all others are landmarks. So how do we decide how much to invest for these landmarks?
This involves a lot of assumptions. We first decide a tentative amount required to achieve that specific target as of today. Let’s say it is ₹50 lakh for that dream car, if I have to buy it today. Then I assume that this cost will increase at 4% per year (basis historical cost movements). So if I want to buy it after six years , I will calculate how much this ₹50 lakh would be growing at 4% for the next six years. Let’s say that comes out to be ₹70 lakh. Now, see how much lump sum investment as of date or a systematic investment plan (SIP) or a mix of both will help me to achieve it. That again is calculated on the basis of an assumed rate of growth of the investment—typically 12-15% per year.
Why I said that the answers to these two similar sounding questions can be as different as chalk and cheese is because many times our ‘should’ comes out much higher than our ‘can’. So while our level of savings can suffice a hatchback, our aspiration is for a top- end sedan. Eventually, we have to balance our personal finances between the two questions. Once you start seeking answers to these questions , you will feel much more confident about your personal finances.
Ankit Garg is managing partner at Wealthy Nivesh, a wealth management firm.
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First Published:3 Dec 2023, 09:56 PM IST
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