How to keep tabs on your personal fiscal deficit, and more

Are you keeping a close watch on your own balance sheet?
Are you keeping a close watch on your own balance sheet?

Summary

While you focus on the Union Budget, here’s a primer on keeping track of your household budget

The Union Budget is around the corner. And naturally there’s a ton of analysis that’s going around. All kinds of wish lists and recommendations are doing the rounds. 

On Budget day, there will be a ton of analysis on what’s right with the government’s balance sheet, and what’s not. A 0.1% unexpected change in the deficit or a fine print on some new tax holds the potential to move the markets significantly.

In all, this is going to consume a total of one week. From now till D-Day. And after that, every month, every quarter, as the numbers trickle in there will be further analysis—actuals versus estimated.

While this is important, here are a few questions I want you to honestly answer: 

Do you prepare a budget for your household, and then track it as the year progresses?

Do you do a post-mortem of how it turned out, and how you need to plan going forward?

Do you know the key ratios for your own balance sheet? What’s your deficit? How much are you investing in income-generating assets? Are you investing in the right places to increase productivity, and hence income-generating capacity?

I could ask many more related questions, but you get the picture. 

I think most of us do some level of planning. But the point is, is that enough? I would hazard a guess here—perhaps not. 

We can agree that budgeting is cumbersome. And we do not have armies of people who will do all the work to produce the data. So it’s kind of excusable that we do not get into the nitty gritty.

But what we can absolutely do, or rather must do, is take care of the “balance sheet" of the household. If you get that right, your profit and loss (income and expenses) should start tracking better automatically. At least to some extent. 

So let’s look at the balance sheet. First, the asset side.

The key questions to answer here are:

How is your wealth invested across assets? Is it in line with your goals?

We have discussed this ad nauseum. Having the right asset allocation in the long term will perhaps be the key determinant of your wealth. So be sure to get your asset allocation right, and in line with your goals. Ideally, you should have a number in mind of where you want to reach. Of course, this could change over time, but it helps to work towards a goal.  

Do you have enough liquid assets to meet near-term needs?

One of the reasons people do not generate wealth is that often when they have a significant unplanned need, they end up liquidating their investments. You must try your best to avoid this. The way to do this is to have an emergency fund, and funds set aside much in advance for upcoming expenses.

How do you treat your so-called assets like “cars/vehicles"?

Well, while accounting rules may suggest these are assets, unless you have it certified (vintage, perhaps), best to assume these are extremely fast-depreciating assets. I would suggest you do not add these up in your assets side. Just pretend these do not exist!

But this is just half the picture. Let’s look at the liability side.

How many loans do you have, and how much do they cost?

About 20 years ago, this would have been an odd question. The only borrowing you probably had was a home loan. Today, one has a home loan, an auto loan, credit card debt, and maybe even a personal loan to meet near-term needs and wants.

While all these loans make it easier to reach out and make purchases that are otherwise out of your budget, what they do is suck up a lot, if not most, of your savings. You have brought forward future expenses, and are paying it with today’s, and future, income. The victim is “savings", which then has a direct impact on your asset-creation.

Without dwelling too much on this, let’s focus on two ratios you should track. These will help you get a solid grip on your balance sheet. 

First is your fiscal deficit.

Add up all your income for a year—salary, rents received, dividend/interest, business profits.

Add up all your expenses for the year—monthly household expenses, vehicle purchase (if any), holidays, house purchase (if any), school fees, interest payments, etc.

The difference between the two is your personal fiscal deficit. 

If you have a fiscal deficit, i.e., you spend more than you earn, you effectively borrow to fill the gap. The more the deficit, the more the borrowing. And that’s not sustainable for very long. 

The other ratio you need to calculate is what is called the primary deficit

Here, what you need to do is take the fiscal deficit calculated above and remove any interest payments that need to be made. What you get is your primary deficit.

What does this tell us? Well, if after removing the interest payments you still have a deficit, it means you need to borrow money to make interest payments. That’s a huge problem. A downward spiral. And that’s something you need to break out of to avoid serious solvency issues. 

One could do a whole analysis of a personal balance sheet. For instance, we could also look at net assets—assets less liabilities—and then track it to see whether your net worth is truly growing in line with your long-term needs.

Another idea, for which I credit Vivek Kaul, an economist, is that one should also track their wealth in units of gold. This ensures that increases in your assets on account of inflation do not give you a wrong sense of real wealth-creation. 

There’s a lot more.  

But if you can start with just these two ratios, and build on from there, you will get a great sense of the health of your balance sheet. 

Happy budgeting to you. 

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477. 

You should always consult your personal investment advisor/wealth manager before making any decisions.

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