Save to Spend – Savend!

Savings.  How much ever boring, clichéd, over-rated, over discussed the term may sound, it is as much important.  The first thing that came to my mind before even starting with this blog was who will even read it when the internet is flooded with people giving ‘gyan’ on savings.  Everyone talks about savings, so what’s so special about this one.  I cannot guarantee anything different, but in line with the intent of ‘ofyi’, this blog will provide you with answers regarding when, how and how much should one ‘save to spend’.  Also, unlike other blogs that you must have read on savings, here I will also try to factor in the expenses that every person needs to incur for his present normal life before saving for future.  We will also deal with each one of the following situations separately:

  1. Young professional who has just started earning with food and shelter being provided by their family / guardian
  2. Young professional who has just started earning with food and shelter to be provided for self
  3. Young professional who has just started earning having a family dependent on him (accommodation available)
  4. Young professional who has just started earning having a family dependent on him (accommodation also to be provided for self and family

Before we proceed further, there are certain assumptions that are required to be made which are as follows:

  • Current age: 23
  • Earnings: Rs 50,000 per month
  • Annual growth rate of income: 20% per annum
  • Marriage: At the age of 28
  • Income of spouse: Ignored
  • Health: Sufficiently insured

 

Young professional who has just started earning with food and shelter being provided by their family / guardian

 

Let’s start with a young budding professional who has just started earning. Food and shelter is provided for by his parents / guardians, so the only thing that he has to spend on is himself.  However, India is also now moving towards the concept of nuclear families and therefore soon he will have to provide for his own accommodation ie when he gets married at the age of 28.

Normal expenses: I would consider the following as normal expenditure to maintain a decent standard of life.  A minor variation in the below estimation can be made to customize it to your spending habits.

Nature of expense

Amount (in Rs)

Clubbing (3,000 x once every week)

12,000

Dinners / lunches (1,000 x once every week)

4,000

Other necessities (60,000 per annum)

5,000

Travelling

4,000

Vacations (30,000 x 2 trips per annum)

5,000

Total

30,000

Now what you are left with is Rs 20,000 (Earnings – Expenses) to start saving with.

Emergency fund: The first thing one must do once he starts earning is to make an emergency fund.  My definition of 'emergency fund' is an investment which is totally liquid and available at your disposal as and when needed.  Naturally the rate of return on such investments is really low.  But then this fund is not really with an intent to earn returns – it is the fund which should be available for use at the time of emergency.  Now the question is how much should be the emergency fund.  According to me, an emergency fund of 5 times your monthly expense should be sufficient (a report on The Economic Times suggests that 6 times your monthly expenses is reasonable which you may consider).  Therefore, in our illustration the emergency fund should be Rs 150,000.  Accordingly, invest all your savings for the first 7-8 months into fixed deposit – best option to create an emergency fund with a reputed bank which can be liquidated overnight.  Other options like PPF, bonds etc often come with riders impacting liquidity.

Saving to spend on accommodation:  At 23 years of age when you start earning and saving, after considering normal expenditure mentioned above and growth in salary, following is what your cash flows would look like upto the age of 28 when you plan to buy your own accommodation.

Age Opening Bal Annual Salary1 Annual Expenses2 Emergency Fund3 Interest Earned4 Closing Bal
23 - 600,000 (360,000) (150,000) - 90,000
24 90,000 720,000 (360,000) - 16,200 466,200
25 466,200 864,000 (360,000) - 83,916 1,054,116
26 1,054,116 1,036,800 (360,000) - 189,741 1,920,657
27 1,920,657 1,244,160 (360,000) - 345,718 3,150,535
28 3,150,535 1,492,992 (360,000) - 567,096 4,850,623
             
1 Assumed an annual growth of 20%      
2 Assumed to be the same till marriage (one may consider an annual increase)  
3 As discussed above        
4 Assumed to be 18% per annum        

As can be seen above, one may have approximately Rs 50 lacs at the age of 28 by saving judiciously after incurring normal everyday expenses.  But to reach this value of Rs 50 lacs I have considered a rate of return on investment of 18% per annum.  This is achievable with equity oriented mutual funds given that our investment horizon is more than 3 years.  This will be explained in detail in my next blog.

Now, having saved Rs 50 lacs, can we buy a house with this?  This depends on location.  Let us consider an example of the city of Mumbai (which is probably the most expensive place to buy an accommodation in not only our country but the world – see livemint report) for our analysis.  An average house for a small nuclear family would be available in the city of Mumbai for 1 crore.  We should consider a cost of Rs 1.25 crore to buy a house at the age of 28 ie 5 years down the line.  What you have is Rs 50 lacs and therefore a balance of Rs 75 lacs would have to be arranged through a long term bank loan which should be easily available given your stable earnings over the past 5 years of career and net worth of over 50 lacs.  The question is how you would pay the EMI that would follow.  EMI would be approx. Rs 60,000 at the current interest rate with a term of over 25 years.  Also, I assume you will start a family at the age of 28 and therefore your monthly expenses and outflow would also increase – consequently your need for emergency fund will also increase as it’s 5 times your monthly expenses.  Therefore, the whole of the analysis provided above would undergo a change from the age of 29, which would be as follows:

Revised normal expenses: I would consider following as normal expenditure to maintain a decent standard of life with a family.  A minor variation in the below estimation here and there can be made to customize it to your spending habits.

Nature of expense

Amount (in Rs)

Clubbing (3,000 x once every week)

12,000

Dinners / lunches (4,000 x once every week)

16,000

Other necessities (180,000 per annum)

15,000

Travelling

10,000

Vacations (144,000 x 1 trip per annum)

12,000

Household expenses and grocery

15,000

Total

80,000

As per our assumptions, with a 20% growth rate in income you would be earning approx Rs 150,000 per month.  Therefore, after incurring an expenses of Rs 80,000, a sum of Rs 70,000 remains with you.  Out of this Rs 60,000 will go in your EMI.

Revised emergency fund: As mentioned above, according to me, an emergency fund of 5 times your monthly expense should be sufficient.  Therefore, in our illustration the emergency fund should now be increased to Rs 400,000.  Given that you already have an emergency fund of Rs 150,000 which would have compounded to Rs 200,000, you need to invest another Rs 200,000 at the age of 29 into fixed deposit.

Saving to spend now on leisure / life / whatever you want:  At the age of 29 now, after buying your own accommodation and getting married, following is something your cash flow would look like going forward:

Age Opening Bal Annual Salary1 Annual Expenses2 Emergency Fund3 Interest Earned4 House EMI Closing Bal
28 3,150,535 1,492,992 (360,000) - 567,096 (4,850,623) - -
29 - 1,800,000 (960,000) (200,000) - - (720,000) (80,000)
30 (80,000) 2,160,000 (960,000) - - - (720,000) 400,000
31 400,000 2,592,000 (960,000) - 72,000 - (720,000) 1,384,000
32 1,384,000 3,110,400 (960,000) -   249,120 - (720,000) 3,063,520
33 3,063,520 3,732,480 (960,000) - 551,434 - (720,000) 5,667,434
34 5,667,434 4,478,976 (960,000) - 1,020,138 - (720,000) 9,486,548
35 9,486,548 5,374,771 (960,000) -   1,707,579 - (720,000)  14,888,897
                 
1 Assumed an annual growth of 20%          
2 Rs 80,000 per month * 12 months            
3 As discussed above            
4 Assumed to be 18% per annum          

There is a small shortage of funds at the age of 29 of Rs 80,000 which will have to be managed by the individual at that time.  Now keep saving and keep spending.

Please note that these are illustrative calculations and one-time expenses like spending on marriage / child education etc have been ignored.

 

Young professional who has just started earning with food and shelter to be provided for self

 

Now let’s consider a young budding professional who has just started earning. However, he is staying away from his family and therefore he has to provide for his own food and shelter.  Therefore, you can consider an additional expense of Rs 15,000 which is an average 'Paying Guest' cost in the city of Mumbai.  Therefore, the total normal expense would be Rs 45,000 (normal expense as per illustration 1 + Paying Guest cost).

This leaves the person only with an initial amount of Rs 5,000 to start saving with (I would recommend the person to keep a check on expenses in the first year to atleast save Rs 15,000).  With Rs 5,000 to start with I would recommend put 50% in the emergency fund and 50% as investment till the emergency fund of Rs 225,000 (Rs 45,000*5) is created.  Therefore, the cash flow will look something like this till the age of 28.

Age Opening Bal Annual Salary1 Annual Expenses2 Emergency Fund3 Interest Earned4 Closing Bal
23 - 600,000 (540,000) (30,000) - 30,000
24 30,000 720,000 (540,000) (90,000) 5,400 125,400
25 125,400 864,000 (540,000) (105,000) 22,572 366,972
26 366,972 1,036,800 (540,000) - 66,055 929,827
27 929,827 1,244,160 (540,000) - 167,369 1,801,356
28 1,801,356 1,492,992 (540,000) - 324,244 3,078,592
             
1 Assumed an annual growth of 20%
2 Assumed to be the same till marriage (one may consider an annual increase)
3 As discussed above
4 Assumed to be 18% per annum

Note:  I would reiterate that this is not an ideal situation as we don’t even have 1 months expenses being covered by our emergency fund and therefore one should keep a strict check on their expenses for the first year and create the emergency fund as much as possible and as early as possible).

Between illustration 1 and 2, other things would remain the same except the savings that the person has made upto the age of 28 ie Rs 50 lacs has come down to Rs 30 lacs.  Therefore, the person may delay the plan of buying a house by a year and the other things will flow as smooth as for the person in the first illustration above.

 

Young professional who has just started earning having a family dependent on him (accommodation available)

 

Now let’s consider a young budding professional who has just started earning. However, his parents / guardians are dependent on him.  Although, he doesn’t have to worry about buying an accommodation in near future, not even when he plans to get married (since his parents are dependent on he, he can’t choose a nuclear family).

Therefore, in that case the following would be your normal expenses:

Nature of expense Amount (in Rs)
Clubbing (2,000 x once every week) 8,000
Dinners / lunches (2,000 x once every week) 8,000
Other necessities (120,000 per annum) 10,000
Travelling 10,000
Vacations (48,000 x 1 trip per annum) 4,000
Household expenses and grocery 10,000
Total 50,000

As seen above, you are spending all that you earn (it is advisable that you keep some check on your spending in the first year to start creating emergency fund).  Therefore, the cash flow will look something like this till the age of 35 (since you don’t have to worry about buying a house I have not provided for a break at the age of 28 – as in the illustration 1, an increased expense to 80,000 has been considered after marriage).

Age Opening Annual Salary1 Annual Expenses2 Emergency Fund3 Interest Earned4 Closing Bal
23 - 600,000 (600,000) - - -
24 - 720,000 (600,000) (60,000) - 60,000
25 60,000 864,000 (600,000) (132,000) 10,800 202,800
26 202,800 1,036,800 (600,000) (58,000) 36,504 618,104
27 618,104 1,244,160 (600,000) - 111,259 1,373,523
28 1,373,523 1,492,992 (600,000) - 247,234 2,513,749
29 2,513,749 1,791,590 (960,000) (150,000) 452,475 3,647,814
30 3,647,814 2,149,908 (960,000) - 656,607 5,494,329
31 5,494,329 2,579,890 (960,000) - 988,979 8,103,198
32 8,103,198 3,095,868 (960,000) - 1,458,576 11,697,642
33 11,697,642 3,715,042 (960,000) - 2,105,576 16,558,260
34 16,558,260 4,458,050 (960,000) - 2,980,487 23,036,797
35 23,036,797 5,349,660 (960,000) - 4,146,623 31,573,080
             
1 Assumed an annual growth of 20%
2 Assumed to be the same till marriage (one may consider an annual increase)
3 As discussed above
4 Assumed to be 18% per annum

 

Young professional who has just started earning having a family dependent on him (accommodation also to be provided for self and family)

 

Now let’s consider a young budding professional who has just started earning.  However, his parents / guardians are dependent on him and he is also required to rent an accommodation till the time he buys his own accommodation.  Now in this case, being in such a difficult situation the person should keep a serious check on his expenses.  Therefore, in that case the following would be your normal expenses:

Nature of expense

Amount (in Rs)
Normal in illustration 3

Affordable in illustration 4

Clubbing (2,000 x once every week)

8,000

Nil

Dinners / lunches (2,000 x once every week)

8,000

4,000

Other necessities (120,000 per annum)

10,000

9,000

Travelling

10,000

5,000

Vacations (48,000 x 1 trip per annum)

4,000

2,000

Household expenses and grocery

10,000

10,000

House rent

NA

20,000

Total

50,000

50,000

As per above, we spend all that we earn.  The cash flow will look something like this till the age of 28.

Age

Opening Bal Annual Salary1 Annual Expenses2 Emergency Fund3 Interest Earned4

Closing Bal

23

-

600,000

(600,000)

-

-

-

24

-

720,000

(600,000)

(60,000)

-

60,000

25

60,000

864,000

(600,000)

(132,000)

10,800

202,800

26

202,800

1,036,800

(600,000)

(58,000)

36,504

618,104

27

618,104

1,244,160

(600,000)

-

111,259

1,373,523

28

1,373,523

1,492,992

(600,000)

-

247,234

2,513,749

             
1

Assumed an annual growth of 20%
2

Assumed to be the same till marriage (one may consider an annual increase)
3

As discussed above
4

Assumed to be 18% per annum

The above table shows that the total saving upto the age of 28 would only be 25 lacs which would be insufficient to buy a house even with part finance being arranged by way of a loan.  Therefore, the person should wait for a few more years to buy his own accommodation.  The cash flow from the age of 28 to 35 with an increased expense after the marriage of Rs 80,000 (refer illustration 1 assuming normalcy on expenses) and an additional 30,000 on rent till the time a new house has been bought will be as follows:

As it can be seen, even in the kind of situation like the one explained above, a well-planned move can take the person in the right direction for achieving normalcy in life with fulfilling all the wishes in time without compromising on any necessities and leisure (except in the first couple of years ofcourse).

 

 

Planning is the Key!

4 thoughts on “Save to Spend – Savend!

  1. Nikhil Jain

    As you have taken salary increment at a std rate of 18% per annum , I want to drive your attention towards the expenses. Even they will have an increasing trend considering the inflation.. Isn’t it?

    1. ofyi Editorial

      You make a valid point which must be factored in while doing the actual calculations for self. The reason why i have not considered inflation on expenses if primarily because the current inflation rate (CPI) is around 2% and expected to remain at this levels. Therefore, it might not have a substantial impact on the outcome of the workings but just make it nothing but a little complicated. All said and done, i agree with you, one must consider the impact of inflation on its expenses.

Let me know your thoughts !!!