Spend or Save

 It is always a conundrum for young earners who are told to save, but they have their own aspirations/desires and FOMO and to be seen as part of the young up swinging crowd.

While it may stem from pent up desires to spend on things you want, UNLESS you are earning a phenomenal amount of money, SAVING is a key ingredient for life long success.

Going out, travelling, buying things for short term use etc. should be done if at least 30% of your salary saving is done apart from your day to day expenses. If money is still left over after that, think of spending. Till such time, belt tightening or holding on to your gratification is key for a financially peaceful old age.

In older generation, investment in the house was key  and once that was done, pension used to take care or expenses were kept to minimal in terms of food/health.

Expectations from children were very high to take them through old age. Saving and Investment was not possible given the frugal income, large family of own and taking care of their parents.

But today's world is changing. The children have their own life and parents should have saved. The children also should start saving as they will be left in a no man's land with parents not leaving much and having spent their money in their youth, find themselves in a difficult situation.

Most of the realizations come when someone is in their 40's when they start to panic as they feel that in next 10-15 years they will retire and do not have the CASH or financial comfort to manage their old age.

40's also brings in panic investment and Banks usually bank on this insecurity and provide products which are more to get commissions than a safety net for the investor.

Believe it or not, a comfortable financial security at the time of retirement will bring far more happiness than the spends done at young age and in particular taking Debts or EMIs. If gratification can be postponed, and savings encouraged when young could lead to a peaceful retirement without the need to worry about the next meal. 

Read an interesting post and thought I will update this post on saving.

Method 1

Suppose you earn 100 - You will spend ,say, 60 on Needs like food/shelter/basics etc., you will spend 40 on Wants - like buying a new phone, new clothes, eating out, entertainment etc. You will end up saving Zero, which will impact you going forward.

Take the other saving scenario. 

Method 2

Suppose you earn 100- you save 20. You will spend 60 on Needs like food/shelter/basics etc. Now you are left with only 20 for your Wants and that will decide which of the want is critical and will buy or wait till you have enough money.

This will ensure you save going by the 2nd method.

The thumb rule for spending money wisely is

50% on Needs - housing, food, transportation, utilities, insurance etc.

30% on Savings -investments, emergency funds

20% on Wants - Travel, entertainment, clothes, electronic purchase etc.

1 and 2 can vary, but ensure the 2nd is maintained as closely as possible to the %age to avoid retirement worries.

 

 

 

THE DEBT TRAP

 Debt - such a simple word, but that is one which puts people into so much trouble.

It is primarily using tomorrow's income today. Debt is such a compounding quicksand that once you fall into it, it is near impossible to retrieve yourself.

When you are borrowing, you are not doing a simple debt, but you are borrowing your future. Living within your means is a universal truth for peace and harmony, but the moment you step into debt, your life is marooned and some at end feel giving away life as the only solution.

Why is DEBT such a bad word. It is because of poor management and thinking. A person in dire strait thinks he can quickly repay the debt, not understanding the interest, the penal interest etc and the pressure to meet the deadline.

Eg. You take 10,000 Rs for 1 year at an interest rate of 8% (which is normally 2-3% higher than fixed deposit interest in normal circumstances, but depending on whom you go to and your credibility and collateral can be 10% or more too).

Thus 10,000 @8% is 800 rs interest. So, you assume you pay 10,800 Rs at end of year. But the loan giver generally deducts interest upfront. So you are given 9,200 only. This makes the rate go to 8.7%. A subtle nuance but significant change.

You default in the first year, saying you will pay in 2nd year as you have used that money and income is not supporting the repayment.

Now it jumps to 10,000*8%=800 or you have to pay overall 10800 when you got only 9200. That is 10800/9200= 17.4%. This quickly jumps if there is a penal interest or you have hoodlums coming and knocking your door.

So many farmers commit suicide in India, till a bit of micro finance came. The local lenders used to charge 50-60% interest and take the children from the parents to work for them. The farmers take small loans thinking their crop will be good their prices will be good and can pay 50-60% interest and return their loan. But unfortunately, they are bonded and whole life they work for these money lenders who exploit them and also take away their lands.

Thus DEBT IS ONE OF THE DEADLIEST MEDICINE TO TAKE AND I AM TELLING ABOUT PERSONAL DEBT.

Companies taking debt, is though equally bad, however has a logic as they expand their business (i.e for revenue generation) by building more capital items. Thus if demand exists, say a cola company, as predicted by a hot summer and company puts manufacturing plant to make extra bottles of cola and sells it, it can recover its money and pay off the loans. Where instead of a hot summer, it is a cool weather, the Company can get into a debt trap.

Reason why the Companies take Debt is something called Debt Leveraging. For a company to get equity funds (no expectation of return, but take the risk that company will pay you good dividends if it makes profit) is difficult as equity holders give out at say Risk free govt bond rate (say 7%) PLUS Risk premium (which can be say, 4%). That is equity holders expect a 11% return. If company can get from Bank @ 8%, and generates income, it effectively saves 3% (11%-8%).

Investors when investing thus look at financials and see if the Debt is reasonable for a company- what is called the Debt/Equity ratio, which is a standard 2:1. You are taking Debt at max of 2 times your equity. Normally, business without hiccups can manage this and still pay a good dividend and helps in expansion in a growth economy. Investors will not touch a Company with Debt in declining growth company as they know that the Company will not be able to service their Debt. This is calculated in another ration called Debt Servicing Ratio (EBIT/Interest). This shows how many times you interest is covered by Profit. Higher the ratio, better is the Company.

On a personal Debt, 

1) Never borrow, unless you have sufficient Assets that can pay off the loans if required. (If you have gold or other FD amount invested and for short term you need Debt, you may take a chance as when time comes to pay Debt, you can sell gold or liquidate FD)

2) Never borrow on the assumption that your income in future will be sufficient to pay off the installments. If income stops for any reason, a huge burden will fall.

3) Never borrow, if you are not 500% sure that it can be repaid in your life time. You may die, but your children, wife carry that burden through generations.

4) Always maximize down payment, in case of large purchase like house, which will keep Debt at a Sane level as well as save on interest to avoid falling into a Debt trap.

5) The Debt trap is sometimes so bad that you get BP, Diabetes (all stress related) and on top of Debt you are burdened with medical expenses and repayment becomes near impossible.

6) Like someone said, Debt is like modern day slavery. Be free.

7) Debt induces Ostrich effect - Bury the head in Sand thinking Danger will be over.