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Get richer by curbing expenses!
Income should not be confused with wealth.
Whatever an individual's income, if his expenses take up all or a larger portion of his income, there will be no surpluses left and as a result, no wealth creation.
It is only when our surpluses are invested that wealth is generated.
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Get richer by curbing expenses!
Two people, despite earning the same income can end up looking very different in a few years - the difference would be as a result of their expenses and their investment.
Hence, having a laser-like focus on just the amount of income is misplaced.
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Get richer by curbing expenses!
They consider the savings to income ratio, liquidity ratio and the debt to asset ratio of a person.
However, intriguingly, even financial planners will leave expenses out of the calculus.
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Get richer by curbing expenses!
This is a very important indicator of financial health. Let us say, Ram earns Rs 50,000 per month.
He spends Rs 30,000 out of his earnings each month and saves the rest. His friend, Bharat, earns Rs 75,000 each month.
His expenses add up to Rs 50,000 at the end of the month and he manages to save Rs 25,000 per month. Ideally on the face of it, Bharat saves Rs 5,000 more each month.
This should add up to a good amount at the end of the year and so he is considered to be better off than Ram.
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Get richer by curbing expenses!
In practical terms, with the savings he manages every month, he will actually be able to pay for 20 days of his monthly expenses.
Let's compare, the same ratio in Bharat's case. His ratio works out to 0.5 (25,000/50,000). This means Bharat will be able to take care of only 15 days' expenses.
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Get richer by curbing expenses!
Even that may not be true if Bharat is supporting a lavish or better lifestyle depending on loans. Servicing more loans does not mean a better lifestyle.
One could be servicing more loans to support unwanted expenses. In any case, even if it were a better lifestyle that Bharat enjoys, he needs to save much more to enjoy the same staying power as Ram.
With respect to this ratio, keeping the expenses within desirable limits is important, rather than focusing on income alone.
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Get richer by curbing expenses!
Even while considering one's expenses, looking at the break-up of how much is being spent on which item will be significant.
For instance, if out of your total expenses in a month, 40 per cent is spent on paying the equated monthly instalments (EMIs) for a home loan, it is fine.
Spending another 20 per cent more to service other loans would also be fine. Assuming that the balance 40 per cent of your expenses gives sufficient leeway for all other expenses. And includes some savings too.
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Get richer by curbing expenses!
You might end up paying a penalty if you miss paying those.
An ideal debt servicing to total expenses ratio would be 0.5 or lower. However, this works well for those in the higher income brackets (Rs 50,000 per month or more).
For lower income brackets, the amount of loan that can be taken would be dictated by monthly or annual expenses, as loans' servicing can be done only after meeting the basic expenses.
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Get richer by curbing expenses!
Here, the debt servicing to total expenses ratio is 0.33. The general logic of having a ratio of 0.5 atleast will not apply here.
Similarly, for double income families with a high combined income, this ratio can go up, to even 0.7, as the balance available may still be big enough in absolute terms to meet the basic expenses and saving needs.
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Get richer by curbing expenses!
A flamboyant spender may see the same corpus deplete in no time. Expenses, hence, play a pivotal role through out life.
Merely focusing on income and investments can be a mistake, a costly one.
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Get richer by curbing expenses!
However, another factor that would determine your future expenses is the aspiration factor-which we shall call the Delta factor.
A hatchback might make one look self-assured today. But aspirations also keep galloping. In future, the same person may be aspiring for a car that is considered up-market.
Once vacations meant going to hometown and back. Now, vacations take one to exotic locations in India and abroad.
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Get richer by curbing expenses!
Considering, it depends on societal and peer pressures, the future contours of which are difficult to define. It also depends on the strata of society they belong to. What may be "arrived" in one strata may be "passe" in another.
How many people would have predicted that they would be sending their children abroad for education, if asked 15 years back? But then, that is what many are doing today.
Building a cushion to accommodate this delta factor, would be a capital idea. It may not be accurate.
But then, estimating it and making at least a rough provision would solve the problem to an extent, instead of completely ignoring it.
The writer is a certified financial planner.
