Conventional wisdom would have you believe that there is an inverse relationship between expenses and investment. that is when expenses increase the availability of money for investments reduces. On closer examination of actual data though, this will only be found to be partially true. Sure, at certain points of time in or lives increased expenses will have a dampening effect on our investments, but there will be periods where both can go up.
In this post, I wanted to give some basic guidelines on how you can manage your expenses and investments over a period of time. As generic guidelines are difficult to relate to, I will refer to my own situation during these same periods to give you a better idea of how things can be managed. If nothing else, you may be able to avoid the mistakes that I have made !!
Stage 1 – The first 5 years of your working life ( 25 – 30 years)
- You will have reasonable expenses and may want to purchase assets like a bike and other durable for setting up your place. With the salaries of today it will still leave you a reasonable surplus to invest.
- Start your PPF and put aside some money for future expenses like your marriage etc.
- Put any additional money available into equity investments, preferably start with MF.
- In my own case, I did not have any great potential for investments in this period. All that I saved was mainly in FD and this was used during my marriage.
Stage 2 – The next 5 years of your working life ( 30 – 35 years)
- You are now married and probably have 1-2 children. Your income has grown but so have your expenses. As a result your availability of money for investment may not have grown much.
- Newer expenses towards insurance and those related to children have now been established.
- Asset purchases like a car and other things will lead to cash outgo in terms of direct buying or through loans.
- You have either bought a home or thinking of doing so soon. As this is likely to entail taking a reasonable amount of loan, your EMI would have started or is about to start.
- Make your financial plan by focusing on goal based investing. You may want to read up the series I have in my blog.
- Continue investing in PPF and MF, increase the SIP amounts as much as you can afford to. You can also start looking at stocks with any surplus amount available. Start small, but try to invest regularly and increase the amount.
- Personally, this was a period when both my children were born and that increased the expenses significantly. I started investing in direct stocks ( MF was hardly available then) and continued my investments in PPF.
- Though my own income increased considerably, my wife gave up her job when our second child was born. This meant the overall money management was still tight. We bought a Maruti Zen car costing 4 lacs, with a loan of 1.5 lacs and managed to pay it off within a year.
Stage 3 – The next 10 years of your working life ( 35 – 45 years)
- These are broadly the school going years of your children. Your career should be in a good phase now and incomes are increasing significantly.
- Your expenses continue to be high and the main components are home loan EMI, schooling for children, insurance.
- Discretionary expenses such as vacations, eating out, entertainment will also peak during this period.
- Asset purchases remain high, you may replace your first car by 1 or even 2 cars in this period.
- Try to pay off as much of the home loan that you can. The interest you pay is a greater drag than the tax benefit.
- Continue your investments in PPF and MF. By now your SIP amount should have reached the maximum level you had planned for. Invest aggressively in direct stocks with the extra money, to build up a robust stock portfolio.
- We managed to pay off the home loan in about 3 years. This was possible due to a higher down payment due to the money available from my wife’s PPF account maturity.
- Change of a job increased my income levels considerably. Apart from adding to my reasonable stock portfolio at this time, I started investing in MF through both SIP and one time purchases.
- Our expenses increased considerably too, discretionary expenses like vacations and eating out contributing the most. Regular expenses like children’s schooling also went up a lot when we admitted them to a good but expensive public school on our shifting to Hyderabad.
- We bought two cars during this period – a Hyundai Accent in 2002 costing 7.5 lacs and a Toyota Corolla Altis in 2009 costing 14 lacs plus. In both instances there were no loans and full payment was made on purchase.
Stage 4 – The final phase of your work life ( 45 – Whatever )
- Ideally, your children have completed their schooling or college by the time you decide to finish your work life or do something else that seems more interesting to you.
- Your expenses remain high due to all the characteristics of the earlier phase till your children complete schooling. At this point they will dip, assuming you are paying for their college education through a goal set up earlier.
- Discretionary expenses will peak with items such as vacations outside the country.
- When you redeem for goals follow the guidelines given in other parts of the blog.
- Continue your investments as before, much of your money should be going into direct stocks now.
- In case, you want to achieve a state of financial independence before your retirement, set up a passive income stream through your dividends, possible withdrawals from PPF, interest from other debt products etc.
- We had planned for most expenses through current income, including a vacation to Europe and Australia. The college expenses for my daughter was largely paid through regular income and she is in her final year now. For my son, we have allocated money for his 4 years of college through some insurance policies that will mature in next 2 years.
- I have set up a passive income stream that will allow me to be financially independent for the next 10 years. IN this period I do not want to touch my equity portfolio which will hopefully grow nicely.
I hope this gives you a good idea of how you can go about things in practical terms. Money management at retirement is a different ball game and I will tackle that in a later post some time.
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