Wednesday, July 8, 2009

Part 2: Where does all the money go?

July 8, 2009

Hello All,

In the last issue we saw what could be the meaning of a "nest egg" or retirement corpus.  I hope you have had time to reflect on what your retirement number might be.  It's not an easy number; neither is it easy to answer the question "what would you do after retirement in case you had enough money to retire?". We don't realize how much we owe to our jobs - it gives us a reason to exist - at the very least, a reason to fill our days with some purpose.  Anyway, I'm sure most of us have a lot of time to figure out the answer to that one!  In the meanwhile, we continue to work, and continue to wonder where all the money went!

Talking of where the money went, do you know where yours went?  Try this small experiment.  List out what you think have been your expenses in the past three months in broad categories.  Once you get that number, compare it with how much you actually withdrew from the bank or cut out as cheques.  The difference is likely to be staggering.  The money just goes; you don't know where.  A little here, a little there, and it's gone - there's no way you can keep track of it.

Talking of investment, etc. is all fine, but first we have to understand how to put aside money.  In the absence of that, all talk of investments is just theory.

The key to solving this puzzle is to understand human psychology.  Do you miss your PF money that gets deducted every month?  Have you ever wished that you could have gone on that vacation in case the PF money had not been deducted for the last one year?  In most (as in 100%) of the cases, the answer is No.  Why is that?  That's because the money was never yours in the first place.  It got deducted at source.  So you never got used to considering that money as yours.

Your neighbor earns probably 3/4ths of the amount you do.  He stays in the same apartment complex, seems to enjoy the same lifestyle, and seems to be, on balance, as happy or unhappy as you are.  He has children and mother-in-law worries just as you do. (In case you're not married make that girlfriend/boyfriend worries).  In that case, why is it that you are not able to save 1/4th of your salary at least?  That's because, try as you might, the money just seems to get spent!

What happens when you get your annual bonus?  When you find that you have a balance of a couple of lakhs in your account?  The mind is very ingenious - it can think of a hundred different things that you absolutely need to have, but don't have.  In short, you are deprived, and you need to address the deprivation immediately.  How about that LCD TV?  If the Agarwals next door can go abroad every year, why not us?  And Kaya skin clinic has a new Botox treatment…. The list is endless.

Utilize human psychology to your advantage.  Put money aside by Paying Yourself First.

Let me explain what I mean.  List down your entire income for the year.  This includes annual inflows like bonus as well.  If you have a spouse and he/she works, list their income as well.  Now, plan what you want to (that should read as "have to") spend for the entire year.  Include all annual outflows like vacations and school fees.  Then follows a simple (A) minus (B) - and what do you get - voila, your savings for the year!  (If A – B is negative, stop reading further. I can’t help you; no one can).

How do you ensure that this planned savings actually happens?

Take your "annual spending" target above, divide it by 12: that's your monthly spending target.  Please note, we have derived a monthly spending target, and not a saving target.  Assuming you have two bank accounts (one yours; one your partner's), open a "Third Bank Account" for diverting this savings.  Every month, as soon as you get your salary, retain only what you have decided is your spending target; cut yourself a cheque for the balance.  Deposit this cheque in your Third Bank Account.  And school yourself to think of this account just as you think of your PF viz., not think of it at all!  Except to worry about how to invest it of course.

Do choose a bank which has demat account facilities and a trading desk as well - while you are at it, you might as well make it investment friendly.  Adhere to the corporate policy on this - make sure it is part of Fidelity's approved list of banks for this purpose.

Do you realize what you have just done?  You have ensured that you will start living within the means that you have set for yourself.  If you continue on your old dissolute ways, you will know by the middle of the month, when you run out of money.  You can't touch the Third Bank Account, since that is out of bounds.  As they say in Kannada you will learn to "Adjust Maadi"! 

Why did we have a spending target and not a savings target? That is to take care of the annual inflows like bonus - having a spending target will ensure that that money goes straight into the Third Bank Account.  The other beauty of this scheme is that you can now spend without guilt, since you have already taken care of the savings aspect.

As to what is to be done with the money kept aside for investment - that will be the subject of several more articles to follow.  However, like I said, all that is theoretical, if you don't "Pay Yourself First" and "Open a Third Bank Account".  Do it!  Do it now!!

And start training yourself to live with some amount of deprivation. 

Adios… till we meet again in the next issue, fifteen days from now!

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