Let us look at how you should go about saving the right amount for your financial goals.
The income minus savings approach
Many people first take care of their household expenses and then whatever is remaining, they will channel it toward investments. However, the way to financial planning is to take the ‘income minus savings and then expenses’ approach.
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Let us say you take the first approach, where you pay for household expenses and then invest. For example, after meeting your household needs, you are left with an investible surplus of Rs 15,000. Then this amount is put in mutual fund systematic investment plans (SIPs) toward long-term money goal which is 15 years away. Now, there is nothing wrong with this, however, the only problem is, was the actual need for the money goal determined? What if the goal needed Rs 18,000 instead of Rs 15,000? You are short by Rs 3,000.
Here is a look at how a ‘mere’ Rs 3,000 shortfall can derail your financial goal. Rs 3,000 in 15 years at 12 per cent generates about Rs 15 lakh. Are you ready for such a shortfall?Also read: How to save for your retirement
Inflation is the enemy of your goals
The more long-term your goal, the more uncertain the amount becomes. Remember, inflation is the enemy of your goals, and slowly and steadily it takes you farther away from them. To tackle it, account for it now so that its impact is minimised. Right from the first day you start investing, you need to factor in inflation and then invest accordingly.
If your goal is to save for your children’s education needs, it is important to initially calculate the future value of the corpus required after adjusting for inflation. This helps in saving the exact amount. This is true for other long-term goals such as children’s marriage. Let us say, the wedding ceremonies and events cost Rs 25 lakh today, could cost Rs 70 lakh after 21 years, assuming a 5 per cent inflation rate. So, one will have to invest Rs 70 lakh and not Rs 25 lakh.
For a goal as crucial as retirement, without knowing the exact monthly savings required, you should not venture into planning and saving.
If you are planning to save for your retirement, first consider your monthly expenses at the current costs. Assuming a 5 per cent inflation rate, find out how much your expenses will be after retirement. This gives you the amount of inflated monthly expenses you will need to survive during your retirement years. After this estimate how much you need to start saving from now till your retirement age to create a corpus that could provide you with the inflated monthly amount.
How inflation impacts target amount
While investing for a financial goal many investors consider the goal’s value at current cost. So if a child’s education costs Rs 10 lakh today, the parent ignores its inflated cost after 15 years and starts saving a certain amount, say Rs 4,000 a month, towards it. After factoring in inflation, of say 7 per cent per annum (education inflation is considered even higher), Rs 10 lakh balloons to about Rs 28 lakh after 15 years. Instead of Rs 4,000, if the investor would have invested an extra Rs 2,000 a month, the target inflated amount (of Rs 28 lakh) would have been achieved.
It’s always better to assume inflation marginally on the higher side and be conservative in assuming growth rate on monthly investments. For long-term goals, invest in equities backed products such as equity mutual funds, assume an annualised growth rate of not more than 12 per cent and inflation of 6-7 per cent per annum.