Saving and investing are the two critical life skills which can secure our financial future.
We work hard to earn money that allows us to live a comfortable life. The money is spent in buying some essential items that we need, and some luxury items too. However, should we spend every penny that we earn?
Spending your entire earning is not advisable for anyone for the following reasons:
- You will not be earning forever. There will be a time when you will retire and your earnings will stop. You will need money to meet your expenses in the years after you retire.
- No one knows what will happen in the future. You might face an unforeseen disaster in your life like a job loss, sickness, disability or an unplanned expenditure for yourself or a family member.
- You will have to fulfil your responsibilities like looking after your family and getting your children educated and married.
- Everyone dreams of purchasing a house or car etc. Which requires large expenses.
To meet these expenses, you should set aside a part of the income that you presently earn every month. This is called saving.
Draw up a budget:
The best tool that will help you to save regularly in a disciplined way is a monthly budget. To start saving, you should draw up a monthly budget in the following way:
1. Estimate and categorize the monthly expenses:
Make a list of expenses that you expect to make every month. Thereafter, divide the expenses into two parts: the compulsory expenses, and the avoidable expenses.
The compulsory expenses would include the essential expenses like paying the rent or power bills of your house. The avoidable expenses include some fancy items. To identify these avoidable expenses, go through the list of expenses and ask yourself whether your life will stop if you do not make that expense. If the answer is yes, then the expenses essential, otherwise it is avoidable.
2. Flag the expenses:
After preparing the list, you should flag the expenses where think you can reduce the expenditure. For example, you may decide to forgo one dinner in a restaurant per month out of the three you normally have per month. So flag the expense as an avoidable item.
3. Estimate your outflows:
Determine that how much money you would need to meet the expenses that are left in the list. You may find out the bills of the last six months and take an average to arrive at an estimate.
4. Calculate how much is left:
Once you arrive at the expected expenditure, subtracted from the income that you receive per month. From this amount deduct any amount that you would need for loan repayment. What will be left after this will be the amount that you can save per month.
As a thumb rule, you should try to save 10 to 20% of your income every month.
I have seen many individuals will create a budget but do not follow it. This makes them go overboard with their expenses, and at the end of the month they find that they have not saved anything. In such a situation, remind yourself that unless you start saving immediately, you will never be able to lead a comfortable retired life. It might also require you to keep on working when you are old and infirm, just because you did not save money when you could have. A regular habit of saving will make your future is stronger and ultimately give you a better life.
Simply saving money is not smart enough
Just saving is not going to be enough. Consider a situation in India. Here, putting money in your savings bank account will get you just 4% in bank interests per year.
However, the average inflation rates from 2012 till 2015 averaged at 8.05%. (It has now come down to 4.41% in November 2015)
This effectively means that if you keep your money in your savings bank account, then you are allowing inflation to eat away 4% of your savings per year.
Let us understand this with an example.
- Say you invest Rs. 100 in your savings bank account.
- You will earn an interest of 4%, i.e. Rs 4 at the end of the year.
- However, in the next year, Rs. 100 would be worth Rs. 92 due to the effect of inflation.
- Hence, the actual return that you would be earning will be Rs. (92 +4) = Rs. 96.
- So your investment of Rs. 100, is now worth Rs. 96. Effectively you have lost Rs. 4, that is 4% of what you had invested at the beginning of the year.
Scary? You bet it is. So how do you combat the situation?
Invest, don’t just save!
The answer is quite simple. You have to find a way in which you will earn returns which are more than the inflation rate. To do this, you will have to invest what you save and not just park it in your savings bank account. Never make the mistake of equating savings with investment. Saving is keeping aside money from your monthly income to meet your future needs. Investing is the activity of choosing an asset which is expected to give you returns above the prevailing inflation rate, and purchasing that asset.
There are various assets, in which you can invest your savings. This would include conservative assets like fixed deposits and bonds, and higher risk assets like shares, equity mutual funds, exchange traded funds etc. When these assets yield you returns higher than the inflation, then you will set out on the path of wealth creation.
Remember that just saving is not enough. Savings will keep your money lying idle, but investment makes your savings earn returns for you. This is the way in which wealth is created by wise people.
Take expert advice:
It is strongly suggested that you speak to a financial adviser who will understand your needs and get you started with saving and investing. Remember that not every asset is suitable for every investor. The assets that you need to choose depends on many factors, one of the major ones being the risk that you are willing to take. Your financial adviser will be able to systematically assess your goals and risk-taking capabilities, and will help you to choose the assets which are suitable for you.
Another matter that you need to remember is that staying invested for a longer period is more likely to give you better returns. Hence, invest for the long-term, and do not turn your investment portfolio unless it is absolutely necessary.
Start Saving and Investing today!
Be wise and start saving and investing it in the right assets and get started on the part of wealth creation. This is the best way in which you can secure your financial future.
If you have any specific questions regarding saving and investing, feel free to comment below.