Everybody wants to be ‘rich’ but very few have actually sat and thought through how rich they really want to be and what they need to do, to achieve financial freedom.
Circumstances and needs are constantly changing. A sound financial situation today does not necessarily foretell an equally rosy future.
A loss of income, even temporary can deplete your savings or leave you in debt.
An uninsured loss can wipe out your accumulated wealth.
Insufficient savings can force you into a reduced lifestyle post retirement.
Frequent or unplanned borrowings can leave negative money i.e. debts for future.
Poor tax planning can result in higher taxes, payable separately.
All this, combined with changes in your life cycle, needs and/ or external economic changes can make you and your future generations financially vulnerable.
You need to plan and manage your current and future income to meet your current and future needs / wants. These are also known as your goals or dreams.
People who write their goals are much more likely to achieve them. Sit down by yourself or with loved ones and try to imagine your future. Consider what drives you in your life and how that has changed over the years.
While I can’t tell you what you should want in life, the list of questions below can provide you with a fair idea of how you should start thinking about the future.
What milestones do you foresee in the future? – starting a family, sending kids to college, buying a new home etc.
When would you want to retire? And with how large a corpus?
What are some of the other things that you may want to do in life?
Once you have a timeline of your goals, you will need to estimate how much money will be needed to meet them.
A portion of your current savings will need to be invested appropriately so that it grows to meet your future goals’ cost.
Make a list of all key expenses you foresee in the future. This will give you an idea of how to invest your savings.
Apart from the percentage amount saved, it is equally important to be constantly on the lookout for improving your savings potential without impacting your quality of life.
No, I am not advocating that you live a very frugal lifestyle and cut back on your consumption – after all, what’s the purpose of earning money if you can’t enjoy it. The idea is to find a right balance between savings and consumption.
If you feel you aren’t saving enough, creating an income and an expense statement as a first step will give you visibility regarding where your money is being spent.
After this, it’s recommended that you create a budget for your expenses.
The first step in creating a budget is to identify the money you have coming in, i.e. your income. Keep in mind, however, that it’s easy to overestimate what you think you can afford if you think of your total salary as what you have available for spending.
Remember to subtract your employee PF contribution, employer PF contribution and income tax. Ideally if you are assessing your monthly saving potential you should not even consider your annual bonus.
Next, start by dividing your expenses into 2 broad spending categories:
1.) Fixed expenses – stuff like your house rent / EMI, monthly food expense (groceries, fruits and vegetables etc.), electricity bills, phone & internet connection expenses, school fee of your children etc. which stay more or less the same throughout the year.
2.) Variable expenses – stuff like entertainment expenses, travel, and medical expenses etc. that can change from month to month.
For both fixed and variable expenses, you will want to record how much you spend under each category. Record this data for a couple of months to arrive at your monthly average expenses.
After you’ve determined what to set aside for your fixed expenses, you can alter the amount earmarked for variable items. The variable category gives you more room in how much you decide to spend and where, allowing you to prioritize as you deem fit. For example, you might decide you can spend less on eating out each month in order to give yourself more money to make a family trip outside India.
You may be surprised, but just knowing how much you spend under various heads will give you ideas on how to cut expenses if required.
Remember, the earlier you start saving, the more you will have later in life. Here is a table that represents the growth potential of savings across income levels.
Scenarios | Individual 1 | Individual 2 | Individual 3 | Individual 4 |
Monthly income | Rs 50,000 | Rs 1,00,000 | Rs 2,00,000 | Rs 5,00,000 |
Monthly Savings (20%) | Rs 10,000 | Rs 20,000 | Rs 40,000 | Rs 1,00,000 |
Value after 5 years | Rs 8 lakhs | Rs 16 lakhs | Rs 33 lakhs | Rs 82 lakhs |
Value after 10 years | Rs 23 lakhs | Rs 46 lakhs | Rs 92 lakhs | Rs 2.3 crores |
Value after 20 years | Rs 99 lakhs | Rs 1.98 crores | Rs 3.95 crores | Rs 9.9 crores |
Assuming the savings grow at an average rate 12 % p.a.
Yes, it is possible to create a large amount of wealth over your lifetime – The key is patience and a disciplined approach to investing small amounts of money every month.