Why do we need money in the first place. Well, if we could do all the things we need to do for leading our lives without having to spend money, then the need for money will disappear. Unfortunately, that has not been the case for several thousand years now and is unlikely to be so for the next few thousands too. We need money for basic needs like food, shelter, medicines ; for mandatory needs like children’s education, EMI ; for discretionary needs like eating out, travel; for indulgences like a world tour or buying a top end car.
The starting point of financial planning is to understand the dynamics of spending and being able to relate it to our individual contexts. This will determine everything else, including how much we need to earn, save and invest. In order to understand the dynamics of spending let me take an example of X again. Let us assume X lives in a Metro city with a family that has his wife and 2 school going children. Note that this a real example, though not a personal one.
The kind of expenses X will be having are as follows:-
- Basic needs – Rent ( EMI ), groceries, utilities, transportation, clothing and other supplies for household.
- Mandatory needs – Education related expenses, insurance expenses, EMI for non-home assets, asset maintenance.
- Discretionary needs – Daughter’s piano lessons, Tuition for children, eating out, vacations.
- Indulgences – Vacation abroad, expensive anniversary bash, buying latest gadget.
The above examples of needs are not sacrosanct but you get my point. Obviously, the first two categories of needs have to be catered for. The next two really depends on your income level and your investment needs based on your future goals. I have seen people wanting to maximize discretionary expenses thereby hurting their investments irreparably. On the other hand I have also seen people so focused on saving and investment that they are miserable in their present. It is important to strike a balance in this. You really do not need to get a new car every 5 years BUT you probably do need to eat out once a week if you love food and the experience of dining out with your family.
Try and relate this to your own life now. Think of the kind of spending you do and how they can be categorized in the above 4 slots. We will discuss in the next posts about investment needs and how to go about that, but the starting point is for you to be comfortable with your spending pattern – understand what you need to spend, what you would like to spend, and finally what you would love to spend but probably should not.
Most of us think that the critical element of Financial planning is to understand stock markets or other financial instruments. Believe me, it is not. You need to understand your spending patterns, how it changes over your life time and what kind of spending suits your personality and income without making you reckless or miserable in the present.
Understanding your need for spending and recognizing how you actually do it in real life is imperative if you want to be in control of your financial life. An useful tool in this regard is the Extended Money Equation which we will be discussing in the next post.
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