When I was starting out in my career and had some money to save, the financial equation prevalent at that time was ” Savings = Income – Expenses”. This made sense in those times 25 plus years back, when most savings went to fixed deposits and LIC with only a handful of intrepid people investing in the stock markets. Over a period of time, with more options available to put your money in and a distinction being made between investment versus savings the equation changed to “Investment= Income – Expenses”.
This was intuitively simple to understand. You earn money through income and then spend money for expenses. The surplus amount you have is channelized into investments for meeting your future financial goals. Over a period of time as financial products industry grew stronger, a new profession of financial planners got established, new modes of investing like SIP in Mutual Funds came into being, there was a concerted attempt to turn the equation on it’s head. The logic primarily went like this – you need to plan for your goals first and need to ensure that your future life is good, even if it means you have to cut corners for now. Complex calculators, built in with mostly wrong assumptions, try to convince you that unless you invest heavily right now and keep doing it, there is no way you will be able to manage anything in future. The outcome of all these efforts is to twist the above equation as follows : ” Expenses = Income – Investment”.
What does this really mean? You are being told that your first priority is investment, so much so, that you need to get it done every month as soon as you get your salary or other income. You will then have to manage your expenses out of whatever is left. Now, this will not be an issue for people who have an income high enough to invest the required amount, as they would still have a lot left for expenses. For these people, it does not really matter how the equation is written, it will work any way. Unfortunately, for a vast majority of people this is really not the situation. For them needing to invest a certain fixed amount mandated by their financial planner or calculators mean that they are not able to have much leeway for any discretionary expenditure at all.
Let me explain through a real life example. One of my readers wanted me to advise him on his current plan. The basic information gathered from him, made very interesting reading:-
- His post tax income was 1.5 lacs, not low by any standards.
- 50000 of this was going to the home loan EMI which has 5 years still to run.
- 10000 was going to PF and another 40000 to SIP through MF.
- He therefore had only 50,000 available. Out of this about 25000 went to the schooling and other expenses of his 2 children.
- This left only 25000 for other expenses and he therefore had little or no room for any discretionary expenses. The family had not been for a good vacation in years and has to depend on any bonus etc for making any purchases of Durable goods.
Much of this was because he had boxed himself into thinking that the recommendations from his financial planner were mandatory. I was able to show him rather easily that there were much better ways of making an investment plan which will allow him enough surplus cash to spend on activities he and his family really wanted to do. With the kind of income he was having, it is absurd that they could not go for vacations etc.
While I can explain my recommendations in another post, the key thing to understand is this. You first need to lead the life that you and your family want to. There is nothing like “paying yourself first” through investment. You are paying yourself first when you are spending on activities or items which are important for you and your family. Yes, you should not be reckless in spending but then, most of us are not like that.
So the equation is very much “Investment = Income – Expenses” and not the other one which has been cleverly concocted by people having serious vested interest. If this results in your not being able to invest enough, there are other solutions to it.
Will take up that issue in another post at a later date.