DT Personal Finance: ‘Save X% of income’ approach may not be enough nor correct

I recently was attending a family wedding and caught up with two cousins who are in mid-30s. In one instance, one of them told the other why he should save 10-20% of his income each month. While the intent of the suggestion was noble, it might not be enough.

Many people will give you unsolicited advice as to why you should save a percentage of your income.

To be fair, it’s not wrong to look at savings from that angle. But while this approach seems intuitive, most often than not, it might not be enough.

Please bear with me as I explain why with a simple example. Suppose you have a monthly income of Rs 1.25 lakh. Your family’s regular living expenses every month are Rs 60,000 and you have a home loan EMI of Rs 35,000 per month.

Now just like my cousin above, you too believed that saving 20% of your income was good enough. So in your case, 20% is Rs 25,000 (i.e. 20% of Rs 1.25 lakh). Since your total expenses (including EMIs) are Rs 95,000, it’s easily possible for you to achieve your targeted 20% savings rate of Rs 25,000 each month.

But let’s see why this may not be enough.

If you do a bit of calculation (related to financial goals and financial planning), you may find out that you have several goals that require monthly investments like the ones listed below:

Daughter’s higher education - Rs 20,000 per month

Daughter’s marriage - Rs 10,000 per month

Own retirement - Rs 25,000 per month (in addition to EPF contributions)

This totals to Rs 55,000 per month. On a monthly income of Rs 1.25 lakh per month, this comes to 44% of your monthly income or the required savings rate.

So while you thought that saving 20% was enough, the reality is that given your financial goals, you need to save at least 44% of your income. Of course, the numbers here are just illustrative samples, but this is what happens exactly with most people.

Don’t get me wrong. I am not trying to say saving 10-20% is wrong. If you have not been financially disciplined and not saving much, then even this figure of a 10-20% savings rate is an achievement in itself. But what I am trying to show here in the example above is that - how much you need to save and invest depends on your goals and not some random-percentage-of-income thumb rule.

Trying to first save 10% and then 20% of income is a good idea. But once you have done that, don’t stop. Acknowledge that your savings requirement may be higher based on your goals. So take some time out and calculate how much you need to invest for each goal. If you can do the maths then great, but if you can’t then take help from good fee-only financial planners to help you figure out the correct numbers. And once you have found the required savings amount, the ball is then in your court.

Suppose you are saving just 20% of your income but after doing some financial planning calculations you found that you need to save 40%. This may not be so easy to do given your current expenses, life stage and responsibilities. If you can’t suddenly increase your savings rate, then you must prioritise your goals, budgets and timelines. You may have to postpone a few non-important/discretionary goals or reduce the budget.

You may also have to try and reduce your expenses a bit (easier said than done but still).

Last but not the least, if you are really unable to save much and also unable to reduce expenses, it only means that you need to work towards increasing your income.

I hope now you understood why saving-a-percentage-of-income may be a good starting point but most probably, may not be enough. Note: The word ‘saving’ has been used above, though practically it stands for both saving and investing.

—(Dev Ashish is a SEBI-registered investment advisor and founder of Stableinvestor.com, who provides fee-only investment advisory services)