. .

Living within means!

Money isn't everything as long as you have enough of it. Malcolm Forbes.

By Altaf Noor Ali & Ayesha Altaf
Sep 17 - 23, 2001

A crude reality of life is that as long as we live we need money at every step to take care of ourselves and our dependents. On the other hand, our earning capacity is not life-long. Unfortunately, for most of us, our earnings remain constant after reaching a certain stage and in fact diminishes completely as we enter the retirement age.

The point to follow is that our spending pattern are life-long whereas our earning capacity is not which makes it very important for each one of us to learn in life the discipline of living within our means. Surprisingly our learning institutions teach us many other disciplines but this one. In the end, we have to learn it for ourselves.

Quite rightly you may well be one of those prudent people who pose this question to yourself regularly. However are you among those who really take the trouble of finding out if you are actually living within your means?

Net worth:

The best evidence of finding out if you are actually living within your means is by knowing what you own. In other words, the result of living within your means is savings which take the form of an asset such as cash, local and foreign bank balance, amounts receivable from others, balance in your provident fund, investments in shares, certificate of investments, saving deposits, house, motor vehicles, etc. Do take a pencil and paper and prepare a list of assets.

You now need to prepare another list of amount owed to others such as personal loans, company loans, amounts owed on credit cards etc. Sum up the list and you get the total amount of liabilities.

From your assets reduce liabilities and the resultant figure from the above exercise is what you can call your 'net worth' (Net worth equals assets less liabilities). This figure can be positive, negative or equal to zero.

If your net worth figure is a positive figure, it is 'an' indication of the fact that you have been living within your means. Your net worth figure represents the amount that you have been able to save. However your net worth needs to be related to your age to draw correct conclusions about its adequacy.

A rule of thumb is that your net worth should be equal to five to ten times of your yearly income by the retirement age.

Example: Mr. A wishes have an income of Rs. 1,200,000 per annum when he retires after few years. He expects the yearly return on national saving schemes to be around 12% when he will retire. These facts mean that at the time of retirement the net worth of Mr. A must be at least Rs. 10 million so that he derives his target income, if he decides to convert his money in cash and keeps it in nsc.

If your net worth figure is negative or zero, it means that you have just joined a huge club of individuals who would like to follow the advice of living within their means but who need to bring in some discipline in their financial affairs.

Zero or negative net worth is understandable for a young person who has only finished studies and started earning. However, for a person in his thirties low net worth should be cause of concern whereas for a person in his fifties or above, it can be a source of absolute financial insecurity. The underlying lesson is that the earlier you start saving and building your net worth, the better it is.

Improving net worth:

There are three major strategies for improving your net worth. The first is to earn more, the second is to reduce your spending and the third is a combination of earning more and spending less.

May be at this instant the most practical and result-oriented strategy for you is to reduce our spending. After all every rupee saved is a rupee earned. Here is how to do it.

Eliminate expensive debt:

Your recommended first priority should be to repay the money borrowed on high interest rates. A sense of urgency on this front will reduce the outstanding amount with every repayment. Equal important is that it will neutralise the high financial charges for 'renting' these borrowed funds.

The exercise of ranking liabilities in terms of percentage per month (or annum) on unpaid balance will start from referring to the list of liabilities prepared for finding 'net worth'. Our goal is to identify the funds that are costing us the most so that we can repay them to reduce our spending on financial charges. Unscrupulous credit card lovers can rightly expect the balances outstanding on credit cards to feature prominently in the list for priority repayment.

You need to make yourself understand that any further increase in the amount owed by you today will bring you even more financial misery tomorrow. If necessary, vow to 'freeze' the existing balance. Resist the temptation for reaching to your wallet and taking out your credit card if they are in your list. You also need to focus your attention on how to bring the outstanding amount to zero.

A basic method for computing monthly repayment figure is to take the total outstanding amount and divide it by convenient number of installments. For example if Rs. 100,000 is payable on your credit card, it can be divided in installments of Rs. 10,000 each. It will take you at least ten months to repay the whole amount. The term 'at least' recognises that the outstanding balance will continue to attract financial charges but each repayment will result in lower financial charges in the next month. You must be aware that it will take you more than ten months to clear the balance.

Once you repay the balance in full and make it a habit to clear the balance in full every month you will find that a credit card statement appears to be at its best for a credit card holder without debit balance from previous months and financial charges. I actual know a person who invariably deposits more than the due amount on his card, to take care of his future purchases. His previous months' balance is in credit rather than a debit balance (amount owed). Most people, however, dread the day the card-statement arrives in the mail. They do not even feel like opening it. The note of caution here is that the blind love affair with credit cards can be expensive and its always recommended that you remain loyal to only one credit card at a time. Have the audacity to cancel the rest.

Another option available to you to reduce your financial charges is to be on a look out for replacing expensive debt with a less expensive one. The balance transfer facility offered by various banks can be useful in replacing debt owed on credit cards.

The moral of above story is to start repaying high cost loan immediately, and stop only after reducing your liabilities significantly. If you devote some time in preparing net worth statement at regular intervals, you will find that your net worth will increase because of reduced financial charges, all other things remaining the same. The most recommended strategy for all times is to be debt-free.

Avoid unplanned purchases:

Soft purchases. How many times it happens that we go out to buy one thing and return with ten different things? It is not to say that those 'extras' were not required, but the question is that if they were required so badly how come you did not went out to purchase them in the first place?

The examples of above situations are buying groceries, eating out, buying clothes or going out. Have you ever noticed that we all end up paying almost double of what we initially estimate in our minds?

The point is that most of us have become slaves to our needs and harbor uncontrolled desire for immediate gratification. In this age of communication, the fact is that we are so much bombarded with consumerism that we are literally seduced by marketing and create an artificial need and that sure is the most indisciplined phase an individual can get to. Also common is to find compulsive shoppers who are restless till the pockets are empty.

The way out is to always prepare a list of items required with quantities when going out for any kind of shopping and then sticking to it. No big issue in adjusting the quantities but no purchases should be made without thinking about it carefully in advance.

There may be thousand other ways to economies on your each item of your spending depending on situation but stopping to watch out everything coming with the word 'sale/discount/win a vacation, prize etc' is not one of them.

The last point that I wish to emphasis is about 'significant but invisible' spending like buying clothing accessories, stationery, birthday cards etc. By careful of spending money on things which do not appear to be expensive in isolation but when you add them up they become 'sizeable'.

Mega and Major purchases. Its again a fact of life that each one of us is involved in once in a lifetime financial purchase like buying a new home or major purchases like a car, television, DVD, stereos, refrigerators, camcorders, cameras, computers or any other consumer product.

The suggested approach in such situations is to carefully assess your needs and to think of options. If there is no option but to buy, the best way is first to go out and see what is available. Internet is an emerging source of such fact-finding. Even if you find what you are looking for, try to defer purchasing it for a week. This one week acts as a cooling period. After one week, if you are still for purchasing it, then by all means go ahead and buy it.

The key principle here is to defer your major purchases to the last extent possible. It should not be seen as denial of something but as a process that eventually benefits you. Even better is that you share your approach in advance with others involved in the decision, such as your spouse or children. Such understanding is critical and will save you from saying 'what the heck, I can afford it!' and rushing you into a decision which is a dangerous pretension. Patience is the key word in such decisions. If you hear such statements often, seriously consider to change the settings of decision to minimise undue pressure on yourself. If you don't, you will probably give in and regret one more wish of yours!

Final Word: Spending money is possibly easiest of things. One can also ignore the importance of living within means and continue to earn from one hand and spend the same from the other, hoping to hit a treasure one day. On the other hand, those who accept this reality prepare to synchronise earning capacity with spending pattern to save something for rainy days.

By no means our advice for anyone is to be a miser. Throughout we have emphasised the need to improve the quality of our spendings by being moderate and vigilant. It is possible to enjoy life within the confines of its financial realities.