Musing 5: Spending Investing Balance

MUSING 5: SPENDING-INVESTING (SI) BALANCE

“Life is a balance of holding on and letting go”- Rumi.

The key to keeping balance is to know when you have lost it”- Anon.

The two quotes above sum up what I intend covering in this and the following musings. Life is all about balance-as students it was about “study-play”, as adults it is about “work-life”, even to remain healthy it is about a balanced diet. Like a balanced diet must contain protein, carbohydrates and fat, a balanced financial life must also contain protein (your Needs), fats (your savings) and carbohydrates (your wants). These three ingredients finally translate to spending and investing in life-spending to keep you healthy in the present and Investing to keep you healthy in the future. Too much of indulgence in the present will adversely impact your future and too much of future consciousness will rob your present of fun, that you so richly deserve. After all, how long can you go on eating sprouts and boiled vegetables but at the same time how long can you afford to have a fat rich diet?

So, translated to our financial health what should be our ideal balance? Let me introduce you to the 50:30:20 Model which is extremely doable due to its simplicity. It not only allows you to put together an optimum SI balance but also acts as a fitness checker as you go along major milestones in your life like marriage, childbirth, retirement and so on. The model has been beautifully explained by Elizabeth Warren and Amelia Warren Tyagi in their book “All your Worth”- another one of my recommended books.

So what is 50:30:20 Model? Simply stated, one should limit one’s needs to 50% and wants to 30% of take home pay (post tax and mandatory deductions). The balance 20% should be saved (read Invested). It is an extremely simple concept and applicable to everyone at whatever level of earning or stage of life. Of course these are thumb-rule percentages and may undergo changes depending on specific situations, which are well covered in the book. What remains to be defined is what constitutes a Need and a Want? Extremely profound question whose answer may vary from person to person, but some guidelines could be laid down.

Needs

So we start with Needs, the 50% stuff. Actually they are very simple and one has to add just one to the well known needs of Roti, Kapda aur Makaan (food, clothing and house). The addition in the list is transportation since one needs to commute for work and play.

So far as House is concerned, it includes rent or mortgage installment one is paying for it. We will tackle the issue of buying a house later as a separate chapter because it is invariably the costliest and longest enduring financial commitment that one makes but suffice to say here that the House rent or mortgage EMI has to fit in this 50% pool.

Clothing needs are obvious but must be restricted to fit within overall 50% limit. After all, a pair of sneakers may cost up to Rs 8.5 lac (yes Nike Mag 2016(auto lace) costs $12500 on auction), but a decent one will be available upwards of Rs 3000, so you get the drift?

Food is slightly tricky because it straddles both wants and needs. A home cooked meal may cost only a fraction of a Pizza with couple of beers; a cup of tea at home may cost 1/100^th of a Starbucks tall Latte. Incidentally, we will devote a full chapter on the Latte Factor later.

Transportation again needs to be contained within the budget of 50%-a cab everyday to and from the office will obviously cost much more than a Metro or some other Public transport. Using Office provided or pool transport is always a better option. I must also hasten to add that if you are eyeing that swanky Bike out there, be notified that the EMI of the Bike must come out of this 50% pool since it will squarely fit into the 50% category of transportation-who said life is easy?

Needs will also include your other basic requirements like communication (telephone bills) other utilities like electricity, gas etc, money required for insurance (being covered later), medical expenses (reason why health insurance becomes so critical) and other minimum legal expenses like minimum due on your credit card, school fee etc. The bottom line for Needs should be-will you keep on spending on these things if you lose your job tomorrow? The second question to ask could be, “can I live without this thing for next 6 months?” If the answer to the first question is yes and to the second one is no, it qualifies as a need.

Savings

We Tackle Savings next. It is the simplest (and toughest) and one has to just follow the “pay yourself first” principle discussed earlier. I feel that 20% allocation should be considered as the bare minimum to ensure quality education for your children and a dignified retirement for you. Anything more will be welcome but if one stretches to save more than 30% of take home pay, one is drifting towards boiled vegetables and sprout diet kind of lifestyle-no fun. Just sock 20% of your take home pay every month and year till retirement increasing the amount each year by 6% to cater for inflation and you will retire rich. Where and how to save or invest for various life goals is a major and interesting question which will occupy a major portion of this book subsequently.

Wants

So that leaves us with the nebulous issue of wants. Wants vary from person to person but few will remain common like outings and movies, gifts for near and dear ones, DTH/cable TV set up, good clothing, a glass of beer and so on. Specific wants could also include keeping a pet or buying a particular type of furniture or painting etc. Be that as it may, the wants must be kept in balance by balancing the Needs and savings. So if one is methodically paying 20% to oneself first and is clear about one’s Needs on which 50% is being spent, rest of the money is available for wants.

The 50:30:20 model provides us with a quick financial checklist and ensures we don’t overspend on any one category. Let’s now see how our protagonist Anshreya who has started earning with a take home monthly pay of Rs 50,000 and relocated to Bengaluru for the job, will adjust to this 50:30:20 model. That comes up in tomorrow's musing.

Happy reading and have a great weekend.