The upside-down approach to financial planning
“I entered the mobile store with a budget of Rs. 20,000; this was the maximum that I could spare, given the current scheme of things. As I started surfing my options, curiosity got the better of me and I found myself intrigued by the new iPhone model that was on display. Of course, I did not want to buy it. It was out of my financial scope. But it came with a mouth-watering deal–a cashback of Rs. 10,000 on my existing phone (I didn’t expect that), and an interest free EMI of Rs. 8,000 per month (for just 7 months). Buying it certainly meant reshuffling my priorities. But the deal was far more tempting than the financial burden that it came with. Not to mention the next few thousands that I spent on accessorizing my new phone and the next few months of emotional and financial turmoil that I underwent.”
This could be any Indian consumer’s story. It could be yours, mine or anyone else who is at peace living with loans and comfortable using those extra bucks for things that we really don’t currently need. Spending on wants rather than needs seem to have become the latest trend, despite the financial inconvenience that follows.
As per a survey, the average household debt of India surged by 1.8 times from Rs. 3.7 lakh crores in 2016-17 to Rs. 6.74 lakhs in 2017-18, growing at an annualized rate of 13% in a period of 5 years. Though this jump was attributed to various forms of bank lending, a steep rise (almost two-fold) can be seen in personal loans and credit cards.
Source: Economic Times
It is astonishing to see how comfortable we have become with the idea of living on credit. So much so, that we are more bothered about satisfying our immediate needs, even if that means spending our earnings in advance.
Have we seriously discounted our future? Believing that there will be no tomorrow? Or left our tomorrow to the mercy of our children, whom we nurture to function as our caretakers in our declining years?
In fact, do we even save enough to ensure that our children are well-educated? Or will that too have to depend on the availability of an education loan? Why not – acquiring a car at 25 and a home at 30 is way more enticing than saving for things like education or retirement? That can happen later. Right?
But, will‘later’ ever arrive? What if you have not saved enough? What if your EMIs outpace your income and savings? What if you get into a debt trap? An ET Wealth survey found that 20% of the respondents took loans to pay the existing loans that they had taken a year earlier. You could be one of them.
What goes wrong?
- “7 out of 10 people in India expect their children to support them in their retirement”, as per a survey by HSBC.
- About 2.5 lakh students depend on education loans to pursue further studies (average disbursement amount: 9.6 lakhs).
- Numerous people under the age group of 25-45 are trapped under personal loans, which amounted to 19.33 lakh crores (June 2018).
- Housing credit accounts for around 10% of India’s GDP.
There is a crazy urgency to own assets. The convenience with which we can avail credit and loans today has led us to the attitude of “buy first, repay later”. We have entered into a strange phase of accumulation. And, in doing so, we have reversed the ideal cycle for financial planning.
This is how we usually plan our lives in the current scenario:-
- Home Loans – At 25- 35 years
- Car Loan – At 25-35 years
- Personal Loan/credit card- At every stage of life
- Study Loan (for children) – At 45- 50 years
- Marriage Loan(for children) – At 50-55 years
By the time we have crossed the 50-year threshold and are left with limited years of earning, we are almost done repaying our existing loans. Retirement planning thus never comes into the equation and we are left with no choice but to depend on others during the most vulnerable years of our lives.
What makes things worse is that our investment decisions are inappropriate. We invest in fixed income assets and debt instruments with a time horizon of 10-20 years but our trust in equities is short lived.
We expect to generate great returns from our equity investments in a span of 2-2.5 years and when that does not happen (equities can certainly not be expected to perform in the short-term), we go back to the traditional form of investing (Fixed Deposits, Bonds, etc.).
Thus, when the debt investments yield about 6-6.5 % interest on an average(post tax), they seem inadequate to repay the interest on our loans.
Today, we take our future incomes and expected salary hikes into account while planning our borrowing and spending. However, with changing economic conditions and lifestyle improvements, many of us carry an EMI burden of about 60% – 70% of our income.
Additional expenses on account of health issues, emergencies, holidays and social events cause further pressure on our finances and put us amid a vicious debt cycle which is difficult to break.
However, Indian tradition allows us to shamelessly pass this financial burden to the next generation and pull on the strings of their financial independence right since the initial years of their work life.
Setting things right: The upside-down approach to financial planning
All you need to do is to rewind your life’s financial planning. Follow an upside-down approach. Plan your retirement first. Prioritize needs over wants. Live your present well but do not forget to secure your future.
Here are a few things that can help you live a good, well-balanced financial life and leave you with enough for your current and future expenses:
Make retirement planning your first priority
Change the order of your financial goals. Make retirement your first priority. Starts investing from the day you start earning. Just investing Rs. 5000 a month in the National Pension Scheme (NPS) for the next 30 years will take care of this extremely significant financial milestone; it will get you approx Rs 1.10 crore. Also Rs 10,000 per month in an equity SIP for 30 years gives a retirement corpus of 3.17 crore, assuming compounding at the rate of 12% per annum for your retirement. And, think of the peace that you will experience knowing that your future is secured at the age of 50. Incredible, isn’t it? Once you set aside a fixed amount for retirement, you will have the time to accumulate enough to buy a car and home or save for your child.
Keep your Debt at < 30% of earnings
As a rule, always limit your debt to less than 30% of your earnings. This will leave you with enough room to meet your expenses, save and invest and avoid a debt trap. Always keep a watch on this ratio and realign your expenses, if need be.
Put needs over wants
Needs over wants is the best philosophy to follow if you wish to live a financially secure life, free of burdensome loans. Take control over your spending. Make a list of what you need and prioritize that. Try and defer things like a luxury gadget or an expensive vacation and invest those extra bucks instead. That will go a long way in contributing to your financial independence.
Create a separate kitty for your children’s education
Merely Rs. 4,000 invested every month in an equity SIP from the time your child is born till he/she is 18 years old will amass to approximately Rs 30 lakh. That’s the only discipline that you need to maintain to ensure a good future for him/her. Create a separate kitty for your child’s education and fulfil your responsibility as a parent. Likewise, make separate investments for different goals in life without letting those interfere with your financial freedom.
Invest in the right products
Once you have laid down your life’s goals and done your financial planning, it is important that you invest in the right products. Always ensure that your earnings from investments exceed the interest paid on loans. Also, look at things from the tax-saving perspective to maximize your ROI.
The buzz word is to stay loan-free as far as possible. Accumulate first, spend later. We do not want you to refrain from spending on what you love and aspire for. A car, home, luxury trips, the latest gadgets, your favourite merchandise- everything is important. If we can defer these desires to the time when we are in a position to service the loans taken for them (post taking care of life goals), or better still save up enough to buy them outright, they would be worth purchasing.
Just think about it – is your debt really worth the pain? Is irrational, unplanned spending worth the financial havoc that follows? A single thought can change everything. Strengthened by discipline and willpower, you can prevent a debt burden from becoming a death sentence.
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.