by Anand Saxena
Needs
We start with ‘needs’, the 50 percent stuff. Actually, they are very simple and one has to add just one to the well-known needs of Roti, Kapda aur Makaan (food, clothing and house.) The addition in the list is transportation as one needs to commute for work and play.
So far as the house is concerned, it includes the rent or the mortgage instalment one is paying for it. We will tackle the issue of buying a house later as a separate musing because it is invariably the costliest and most enduring financial commitment that one makes but suffices to say here that the house rent or mortgage EMI has to fit in this 50 percent bucket.
The clothing needs are obvious but must be restricted to fit within the overall 50 percent limit. After all, a pair of sneakers may cost up to ₹8.5 lakhs (yes Nike Mag 2016 (auto lace) cost $12500 in an auction) but a decent one will be available upwards of ₹3000, so you get the drift?
Food is slightly tricky because it straddles both wants and needs. A home-cooked meal may cost only a fraction of the cost of a pizza with a couple of beers; a cup of tea at home may cost a hundredth of a Starbucks tall latte. Incidentally, we will devote a full chapter on the latte factor later.
Transportation again needs to be contained within the budget of 50 percent. A cab every day to and from the office will obviously cost much more than a metro or some other public transport. Using office provided or pool transport is always a better option. I must also hasten to add that if you are eyeing that swanky bike out there, be notified that the EMI of the bike must come out of this 50 percent pool since it will squarely fit into the 50 percent category of transportation. Who said life is easy?
Needs will also include your other basic requirements like communication (telephone bills) other utilities like electricity and gas, money required for insurance (being covered later,) medical expenses (reason why health insurance becomes so critical) and other minimum legal expenses like minimum due on your credit card or school fees. The bottom line for ‘needs’ should be: Will I keep on spending on these things if I lose my job tomorrow? The second question to ask should be: Can I live without this thing for the next 6 months? If the answer to the first question is yes and to the second one is no, it qualifies as a need.
Savings
We will tackle ‘savings’ next. It is the simplest (and the toughest) part of this paradigm and one has to just follow the ‘pay yourself first’ principle discussed earlier. I feel that a 20 percent allocation should be considered the bare minimum to ensure quality education for your children and a dignified retirement for you. Anything more will be welcome but if one stretches to save more than 30 percent of the take-home pay, one is drifting towards boiled vegetables and sprout diet kind of lifestyle; no fun. Just sock 20 percent of your take-home pay every month and year till retirement increasing the amount each year by 6 percent to cater for inflation and you will retire rich. Where and how to save or invest for various life goals is a major and interesting question which will occupy a major portion of this book subsequently.
Wants
“All men are burdened with more desires than they can gratify8.”
That leaves us with the nebulous issue of ‘wants.’ Wants vary from person to person but few will remain common like outings and movies, gifts for near and dear ones, DTH and cable TV set up, good clothing, a glass of beer and so on. Specific wants could also include keeping a pet or buying a particular type of furniture or painting. Nevertheless, the wants must be kept in balance by balancing the needs and savings. So if one is methodically paying 20 percent to oneself first and is clear about one’s ‘needs’ on which 50 percent is being spent, the rest of the money is available for ‘wants.’
Debt Repayment
The mortgage of the housing loan is to be paid out of the 50 percent bucket, but what about the other debts that one may take? Car loan, student loan or even additional payments for clearing the house mortgage early also need to be catered for. The 50:30:20 model recommends that a 10 percent amount (out of the 20 percent savings bucket) be set aside for debt payment (50:30:10:10.) A variation of this model is suggested by George Clason in his book, ‘The Richest Man in Babylon,’ wherein he suggests a 10:70:20 model. Hence, 10 percent is set aside for savings, 70 percent for wants and needs and 20 percent for debt repayments. Whichever model of debt repayment we go for is fair, as long as we cater for it before taking on a new debt.
The 50:30:20 model provides us with a quick financial checklist and ensures that we don’t overspend on any one category. Let’s now see how our protagonist Anshreya who has started earning a take-home monthly pay of ₹50,000 and relocated to Bengaluru for the job, will adjust to this 50:30:20 model.
Anshreya must not spend more than ₹25,000 on her needs (50 percent of take-home pay.) So, she must manage her house rent, basic clothing and food needs and other utilities like mobile or internet bill, fuel for bike or scooty (if she has) or other transportation expenditure and electricity or water bills out of this amount.
The biggest chunk is likely to be for house rent. As a rule of thumb, not more than 50 percent of needs budget should go towards house rent, ₹12,500 in this case. She may have to compromise on the location of the house if a good house, close to her place of work is not available within her budget of ₹12,500. Remember, other expenditures connected with house like water and electricity charges must also be catered for within this amount. A good idea would be to share the apartment with friends or go for a paying guest (PG) accommodation. Don’t even think of buying a house at this stage, we will tackle this issue later.
Now, Anshreya has ₹12,500 left to take care of her remaining needs, the most important of which is food. As per the job schedule, her lunch is going to be at her office only, for which normally organisations provide very reasonably-priced menu. She must avail of the same. For breakfast and dinner, she would need to tie up either with her PG or employ a maid who prepares her breakfast and dinner. She can’t afford a dinner at a restaurant every day as her health and pocket wouldn’t permit the same.
The transportation needs could be best tackled with a public transport like a metro or bus. If not convenient, an office shared cab would be a good option. Over a period of time, she can plan to buy a bike or used car (yes, a two-year-old used car and not a new one) to save on her transportation costs. She needs to save money to give at least 20 percent of down payment towards bike or car cost. The balance could be paid in form of EMI which have to come out of her ‘needs’ budget. This automatically puts a cap on the cost of the bike or car. Do not even think of a Hayabusa or Harley Davidson in the initial years of earning. How does she save for the 20 percent down payment? By setting aside 5 percent of her take-home pay, out of the 20-percent savings bucket, ₹2,500 in this case, towards this goal. On no account should more than 5 percent of take-home pay be earmarked for this purpose and the balance 15 percent of the payment must be saved.
Clothing needs require some upfront expenditure as Anshreya may require some formal clothing for office. It is better to find out the requirements before joining and buy the clothing from her hometown in conjunction with her parents. All other clothing needs, once she joins, will have to be met out of her overall 50 percent needs bucket (if it’s a need for the office) or 30 percent wants bucket (if it’s an aspiration,) so she needs to be selective and prioritise accordingly.
The savings bucket (20 percent) is sacred and in this case, ₹10,000 per month must be invested to create a “breathing fund”. We will cover the details in following musing. As discussed earlier, if buying a bike is a priority, ₹2,500 (5 percent of take-home pay) must be set aside for creating a corpus for 20 percent down payment of bike.
Now we reach the ‘wants’ bucket (30 percent) for which Anshreya has ₹15,000 for the month. This she can spend in any way she wants: movies, outings, sneakers, books, pizza, new mobile, the list is endless. One probable way could be to divide this amount into weekly sums of ₹3,500 – 4,000 in this case. Normally, she will get free
time in the weekends and here she can spend this weekly sum. Weekly budgeting will ensure that she doesn’t dip into her savings or needs bucket for her wants. And absolutely, no spending on wants from the next month’s budget (credit cards will tempt her to do that.) Once the weekly or monthly ‘wants’ money is gone, it’s gone.
This will also be the life stage when the loan sharks in form of credit card, bike and car offers start chasing Anshreya. Beware of them as she has to methodically increase her net worth and create a balanced life for herself without being saddled with costly and pernicious EMI. We will tackle the issue of credit cards in a subsequent musing.
The 50:30:20 or the SI balance must be checked regularly, maybe twice a year and prior to major changes in life like marriage, childbirth or promotion. The best part about the SI balance is that one doesn’t have to fret about personal finances once this balance is achieved. Let me give some rule of thumb percentages9.
Needs bucket (50 percent bucket) – Under 35 percent: good show; 35-50 percent: in balance; 50-65 percent: danger zone; more than 65 percent: disaster zone.
Savings bucket (20 percent bucket) – more than 20 percent: super big saver; 10-20 percent: strong saver; less than 10 percent: pull up your socks or you are staring at a poor retirement.
Wants bucket (30 percent bucket) – 20-30 percent: wants in balance; less than 20 percent: all work and no play; more than 30 percent: splurger-beware.
Key Takeaways
As soon as you start earning, or anytime in life, look for and calculate your SI Balance. If not within 50:30:20, start by cutting down on wants followed by needs. Savings must remain 20 percent without fail.
One will not strike a perfect 50:30:20 budget right in the beginning. Still, a 55:30:15 budget is better than a 60:40:0 one. Always balance your needs bucket first—towards 50 percent before tackling other buckets. Little iteration may be required before arriving at rule of thumb percentages depending on individual to individual.
Relook at SI balance every six months or prior to a major life change like marriage and childbirth or decision to buy a house or car.
If you are saddled with a credit card debt, personal loan or any other debt except home, education loan and car, the minimum monthly payment will form part of needs bucket but additional payments to clear off the debts faster will have to come out of the savings bucket (not more than 5-10 percent of take-home pay.)
Wants must fulfil the aspirations of both partners after marriage.
MUSING 5: THE ONLY WAY TO BUDGET
DON’T BE PENNY WISE AND POUND FOOLISH
If there is one activity from conventional financial wisdom which is universally hated and thus not going to work, it is budgeting. I have tried all conceivable methods of budgeting, from very rudimentary to the most complex and trust me, none of them work. After a few weeks of counting and accounting pennies, you stop budgeting altogether in sheer exasperation. However, after trial and error, there are two techniques that I have found that work, and honestly these two are the only ones which are required to have a smooth monthly or yearly budget. Let’s discuss them one by one.
Zero-Based Budgeting (ZBB)
Before we discuss ZBB, we should remember that budgeting is nothing but a plan to tell your money where to go instead of wondering where it went? The fundamental behind the ZBB is that there can be no ideal month as far as your expenditures are concerned. Even so-called planned expenses like school fee, insurance premiums, festivals and vacations fall in particular months. What further adds to the complexity is that even your pay is not constant each month. Deductions and Income Tax will vary this amount as well. Keeping these two factors in mind, one has to budget for each month afresh keeping the expenditures lined up for the month in mind or in other words assigning every rupee a name and place to go, every month.
We are clear that we have put 20 percent of our money towards investments (savings bucket) which is sacrosanct and are thus working towards our needs (50 percent) and wants (30 percent) buckets here. ZBB, done around a week before the next month starts, stipulates that each and every prospective expenditure is first accounted for and then a rupee value assigned against each.
For ZBB, one can create five basic heads under the ‘needs’ column: Food, housing, transportation, utilities and clothing. So, if you have to pay your house rent in the coming month which is ₹10,000, then against the item ‘rent’ write ₹10,000. Similarly, all other likely expenses will be accounted for and a rupee amount assigned to them.
Similarly, a column for ‘wants’ will be created containing all possible subheads like outings, movies, new Jeans, gym membership fee and so on and the expense assigned against each. Now, you know, a full week before the next month has to start that you need X amount on 1st of the month (assuming that you get paid on 01st of each month) for your needs and wants. On the first of the month, there could be three contingencies: one that the pay will be exactly the same as the required amount (unlikely,) the other two would be the pay being less or more than the required amount.
If the pay is less than the required amount, some trimming from expenses for needs and wants is to be done. As we discussed in the musing on SI balance, the wants are the ones which will have to be pruned down first. For example, if the pay is less by ₹2,000, the Jeans that you had planned to buy this month will have to wait for one more month or you cut out one outing out of four planned for the month. The type of want that will get omitted will differ from person to person and their aspirations. The bottom line is that the individual expense will have to be trimmed down until the overall expenses equal the pay for the month.
If the pay is more than expenses, it is not treated as free money to be spent on discretionary spending. You need to tell this extra money in advance, as to where it should go. So, if you manage to get ₹2,000 extra in the pay, you may decide to buy two Jeans instead of one or give a surprise treat to your wife or simply create a reserve for a rainy day. Whatever you do is your decision but should be a well-thought-out one.
Envelope System
This is a corollary of the ZBB. One has to create envelopes for various expenses like groceries, vegetables, school fee, gas cylinder, outings and so on. Once the expense for each is decided upon, withdraw the amount from bank and keep in the relevant envelope. Yes, this system requires you to deal in cash as much as possible. One keeps on spending from the relevant envelope as the month progresses and once the money from the envelope is gone, it’s gone. So, if the money from ‘outing’ envelope is over by the 20th of the month, no more outings for the next ten days.
One can sense an immediate reaction from you: Carrying and spending cash in this age of plastic? Why not decide the amount and then keep paying by card. The reasons are these: Firstly, it is difficult to keep track of the expenses by card as one can easily end up overspending. Secondly, the card swiping doesn’t invoke the pain of parting with money as much as counting the cash and handing over to the shopkeeper or vendor. The situation will be worse with a credit card where one will invariably end up overshooting the monthly budget thus spending out of next month’s pay.
The issue of expenses which can be anticipated for the entire year like anniversaries, birthdays, annual tuition fee for the child, vacations and festivals should be planned slightly differently. If you intend to spend ₹50,000 on your yearly vacation, simply divide this amount by twelve and save ₹4,000 (approximately) every month. Keep putting the money in a liquid fund through SIP or open a Recurring Deposit in bank for 12 months maturity (we will look at these issues in depth later.) This way, your dream yearly vacation will be catered for without impacting your budget for that month.
Key Takeaways
The 50 percent (need) and 30 percent (want) buckets should be budgeted using ZBB and envelope systems.
An accurate assessment of all likely expenditures, monthly and yearly, should be done before the beginning of the year and month as the case may be. The yearly expenditures like vacations, anniversary and
festivals should be assigned an amount of expenditure and divided by 12 to get a monthly amount. Each month, this amount should be set aside as part of the wants (festivals or anniversary etc.) and needs (school fee, car insurance etc.) bucket.
The monthly expenditures should be adjusted against the monthly payments, beginning with cutting the ‘wants’ amount if the pay is lesser than the projected expenses.
Finally, the amount should be kept in the relevant envelope and spent out of it until it reaches zero.
MUSING 6: THE BREATHING FUND
You must have heard of the Murphy’s Law which states, “Anything that can go wrong will go wrong.” I have invariably found it true in life situations and especially as far as my financial life is concerned, Mr. Murphy will generally be accompanied by his cousins, debt and loan. Our epic scripture Bhagwat Gita states, “Whatever has to happen will happen,” but that does not absolve us from being prepared for Mr. Murphy and his cousins. One easy way of doing it is by creating a “breathing fund”, which allows you to sleep peacefully at night in spite of what life may throw at you financially.
Most of the financial experts agree on this breathing fund (also referred as emergency fund) to be large enough to cover 3-6 months of one’s expenses. This is adequate to cater for unforeseen emergencies like your bike or car needing major repairs or your AC packing up in the middle of the summers. How should one go about creating this breathing fund? We will work along with our protagonist Anshreya, who is still earning ₹50,000 per month; Remember, she is supposed to live on 80 percent of her income (wants and needs) and save or invest the remaining 20 percent. So her 6 months expenses come to ₹2.4 lakhs (6*₹40,000.) Now, till the time this breathing fund is built up to ₹2.4 lakhs, Anshreya is not putting any money into her long-term savings but instead socking this 20 percent to accumulate this fund. She should be putting this money in a safe instrument like savings bank, Money Market Account or liquid fund, from where she can access it within a day and at the same time is assured of capital protection. We will be visiting all the available financial instruments later.
