Financial Liberty through Prudent Saving

Financial Liberty through Prudent Saving
Financial Liberty Through Prudent Saving
Sundara Rajan - 11 September 2021

As per a 2021 PwC survey, finances are the top cause of employee stress, impacting productivity and well-being. Globally, the pandemic has forced people to re-visit their finances, making them realize that being financially prudent is a pre-requisite to living a happy and productive life. While it is true that money cannot buy you happiness; it can certainly enable you to have more control over your life, more freedom to carve out your path, and have fewer constraints on your choices.

Why is Money Important to You?

The first step in managing money is to develop a financial and investment plan. At the outlet, try asking yourself “Why is money important to you?”. The answer to this question will determine the values that will drive your financial planning decisions. When fraught with a choice, it will aid in prioritizing your financial goals.

Frugality and Savings

Frugality and personal savings, the cornerstones to realizing one's financial goals, are those parts of the money equation that are more in our control. In a world where imitation is at the heart of being human, it is difficult to fight our instincts to keep up with others. Concededly, savings can be defined as the gap between our ego and income. Thus, one of the most powerful ways to increase our savings is to raise our humility.

Budget: A Tool for Awareness

While it is fundamental to identify our financial goals, it is equally important to understand where we currently stand, to be able to chart a road map to achieve the end objective. It's a no-brainer that budgets just serve this purpose by providing valuable insights into our spending pattern. This awareness could be used to consciously influence our behavior, rationalize impulsive expenditure, and make certain our savings are aligned with our financial goals.

Getting Started: How to Save?

For beginners, the 60 per cent solution, popularized by renowned finance journalist Richard Jenkins is a feasible template to start saving. Jenkins suggests “committed expenses”- essential expenses and non-essentials we have committed to (food, rent, insurance premiums, recurring expenses, taxes, subscriptions), be limited to 60 per cent of gross income, and the other 40 per cent be Allocated as follows: 10 per cent for retirement savings, 10 per cent for long-term savings (towards loan payments, children's education), 10 per cent for short-term savings (for emergencies and uncertainties) and 10 per cent for fun money ( for travel, entertainment, etc.). This is not a fool-proof technique and may not be feasible for everyone, however, it sets a benchmark to get initiated.

Automating Savings

One of the most efficient strategies to save more is to automate savings whereby money is re-directed from the bank account even before it is made available for use. This way, any temptation to spend extra money doesn't materialise. Additionally, innovative online tools may also be used, such as "round-up apps" that let people automatically save their spare change by rounding up everyday purchases to the nearest tens or hundreds. Eg if we spend 565 rupees on groceries, the app will automatically transfer 35 rupees to our savings account.

Diversification of Portfolio

Once you have started saving, investing judiciously is paramount. There is a fear of losing money in the stock markets because of its volatility, and hence the tendency to invest more in real estate or gold. However, there is a need to diversify your investments to not let one bad call affect your perspective towards investment.

To being with, starters can buy mutual funds (including the nominal amount of monthly SIPs) or exchange-traded funds, which give broad exposure to many different companies while lowering the chance of picking the wrong stock or sector to invest in. Other investment avenues such as government bonds, sovereign gold bonds, etc. tend to move in a direction opposite to that of equity stocks. By hedging against any unilateral downside, these investment options bring a balance to the portfolio.

Compounding - Eighth Wonder of the World

While it is trite that a higher saving rate could ease future financial commitments, what is more, pivotal is the time horizon over which savings are invested. It is better to start saving early to realize the power of compounding. Compounding is simply the game of time - you let money make money. And the money that money makes, makes more money. Thus, even small annual growth over a long period yields exorbitantly higher returns. To put it in perspective, a sum of money that grows by 2 percent each year for 20 years will have increased by about 50 percent after the end of 20 years.

Room for Error

Savings and investments should be monitored at regular intervals to ensure our current actions are within the realm of reasonable. However, one should not be obsessive over these goals, as humans are most susceptible to change. When estimating future returns, always use the room for error. The room for error lets you endure a range of potential outcomes and stick around in the long run, to let the odds of benefiting from a low probability outcome fall in your favour. It keeps you in the game and by not interrupting your money plans consistently, you unravel the magic of compounding.

Change might not be fast, and it isn't always easy. Start off small, start off early, consistently remind yourself why money matters to you, become more reflective about your spending, and explore different investment avenues. Make saving a habit and follow it religiously. Always remember, the pain of discipline is way less than the pain of regret!

The author is TK, Partner at DVS Advisors LLP

DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organization directly or indirectly.

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