A perennial issue that most earners face today is how to balance their spending and investments, given the pulls and pressures of daily life. Our monthly expenditure is largely dominated by items such as EMI for home loan, EMI for car/other loans, School going expenses of children, variety of insurance related expenses etc. Based on these and the goal based investment levels proposed by the different calculators or financial planners, many families are taking a hit in almost eliminating their discretionary expenditure. This may make your finances look good on paper but certainly takes out a lot from the joy of living your life the way it ought to be lived.
In one of my earlier posts I had referred to a real life situation that many investors belonging to the high income group are facing today. I have deliberately chosen to demonstrate the situation with a high income group person, so that the acuteness of the problem can be underlined in an emphatic manner. Needless to say, people who are earning less will have even more of the same problems.
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.
So what are the possible preventive actions that could have been taken not to land up in this situation? Firstly, the investor could have fixed his home loan EMI amount in line with his income. In general, the EMI should not be more than 25-30 % of your overall monthly post tax income. Secondly, given that the home loan interest rates are in double digits, it makes sense to aggressively pre-pay the home loan whenever some one time payments become available in the job. Thirdly, while his calculations may show correctly that he needs to invest 40000 in SIP over the next 15 years in order to meet his goals, there is a fundamental flaw in this. The SIP amount does not need to be at an uniform level, in fact it will be rather silly for us to do it that way. After 5 years he will not have the home loan EMI to pay and can easily invest a lot more at that time. I have always been surprised as to why the calculators and planners fail to understand this simple issue.
But coming back to this specific case, my recommendation for this investor was as follows:-
- Liquidate some of his fixed income assets like FD and Debt funds which were paying him significantly less than the interest on his home loan.
- Reduce his SIP investment to 30000 a month and keep the 10000 in a liquid fund for any discretionary expenditure that could come up.
- Any variable pay or bonus was to be used for pre-payment of home loan. After this was over, part of these could be invested and the rest could be again kept in the same liquid funds where the monthly 10000 was going regularly.
- Any increments annually would again be divided partly for investments and partly for funding purchase of any discretionary item for the family.
What was the impact of the plan? In one word the family were able to do much more with their lives and lifestyle than before and this resulted in genuine happiness. In tangible terms they were able to see these changes :-
- A fortnightly dinner outing was now possible along with a weekly dinner from one of the fast food joints for the children.
- The family could take a vacation within India for a week every year.
- They could also take a vacation outside India once every 3 years. This was easily made possible by redeeming the money in liquid fund.
- The home loan was paid off in less than 3 years.
- All the investment goals were well on track though the route was a different one now.
As you would have seen from above, a financial plan is really a combination of some knowledge and a lot of common sense. Being a prisoner of calculators and financial planner was preventing this family from leading the life they ideally wanted to live. I am very happy that I was able to play a role in showing them the right path.