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Savings : Why is it important to maintain an appropriate ratio?

Written by - Naren

May 4, 2023 6 minutes

Warren Buffet once said “Do not save what is left after spending; instead spend what is left after saving.” Savings, though of immense importance, is often neglected to a great degree. Savings are important for everyone in India because it offers a safe avenue to park surplus funds. It can help you deal with unexpected costs and emergencies, reach your short, medium and long term financial goals like saving for a car, your children’s education, a house deposit or your retirement. It also gives you peace of mind and expands your options for decisions that have a major effect on your quality of life. 

Most people who are wealthy got there through a combination of their own hard work and smart savings and investment decisions. Here, we discuss the importance of savings, how best to plan out savings and make it work for you.

Understanding the concept of savings

When we save we store up for our future. Saved money when invested earns for itself. Take the farmer for example. Out of the bountiful yield he receives from months of hard work he keeps aside some seeds for sowing in the next season. What would happen if he and his family merrily ate up all the harvest? What he could have afforded out his own produce now he would be forced to buy for a cost.

Saving is akin to that. But we need to save much more than seeds! In fact due to the eroding effect of inflation a sizeable chunk of earnings might have to go to your savings kitty every month.

However a quick reminder of why maintaining a healthy savings rate is important, might change your outlook of savings from probably being an imposition activity to be avoided or minimized to one that you will be glad to do.

What do we need adequate savings

There are only two reasons why you need to have enough savings. The first is that someday, years down the line, your monthly cash inflows will stop as you retire from work. You would require funds from a different source to keep you and your spouse going for the decades to come.

Second, certain needs that are expected to come up along the way are too bulky to manage with just monthly or even annual income. Unless you planned and saved for them you would be forced to resort to loans.

For instance you cannot buy a house or a vehicle like you’d buy things from the grocery store. Or you cannot enroll your child in a college unless you have arranged the funds. Sure you can borrow without saving and repay from your monthly inflows but this would leave you with less money in hands to spend for your regular needs.

How much savings is enough?

Your ideal savings rate depends on how much money you require in future for lifestyle needs as well as for fulfilling the big liabilities. Of course nobody knows the future and it might not be possible to accurately plan for every single rupee of your future goals but you can estimate the amount based on your current lifestyle.

Thus your ideal savings rate depends on your 1. Life-stage, that is whether you are single, married or have kids to support etc, and 2. Financial liabilities, that is if you are paying off loans, paying rent etc. Going from a merry single to being married, having kids and paying home loan EMIs, your savings rate would lay between 15% and 50%.

How much you earn is not important; if you just somehow manage to save at the appropriate rate your future needs will be met comfortably. The earlier you start, lesser will be the monthly amounts you’d have to keep aside for future goals because you have more years to save and get there! Budgeting and tracking of expenses is one simple yet effective tool to achieve your targeted savings rate.

How do I achieve my monthly savings target?

Now this is the million dollar question. Being able to maintain a healthy savings rate does not mean you would be pushed to live a miser’s life. But depending on your current lifestyle you might have to rethink your financial strategy or approach. If we talk about the long run, may be 15-20 years down the line, every small saving that you can add today will be worth a lot more by then.

Here are some examples with numbers to illustrate how you can achieve your monthly savings target in India:

  1. Create a budget plan: Let’s assume your monthly income is Rs. 50,000, and your monthly expenses are as follows:
  • Rent: Rs. 15,000
  • Food: Rs. 8,000
  • Utilities: Rs. 3,000
  • Transportation: Rs. 5,000
  • Entertainment: Rs. 4,000

Total expenses = Rs. 35,000 Savings = Income – Expenses = Rs. 15,000

  1. Track your expenses: Use a budgeting app or spreadsheet to keep track of your expenses. For example, if you spent Rs. 1,000 on dining out, Rs. 500 on a subscription service you don’t use, and Rs. 2,000 on shopping, you can cut back on these expenses and save Rs. 3,500.

  2. Cut back on unnecessary expenses: Let’s say you reduce your dining out expenses to Rs. 500, cancel the subscription service, and limit your shopping expenses to Rs. 1,000. This way, you can save Rs. 2,000 per month.
  3. Automate your savings: Set up an automatic transfer of Rs. 10,000 from your salary account to a savings account each month. This way, you can save half of your monthly savings target without even thinking about it.

By following these steps, you can achieve your monthly savings target of Rs. 15,000 in this example.

Conclusion

It is important to distinguish between needs and wants. It a useful habit you need to cultivate to have a balanced financial life in the long term. Needs are the basic necessities you can’t do without. When you have identified your needs like rent, telephone, utilities you will know how much you have left to spend on wants. Wants are basically desires you’d like to spend on.

It is not wrong to satisfy your wants but just remember not to do it at the cost of your needs or the likely consequence is – you will fall in debt. If you want to succeed in living happily within your means don’t dress up your wants as needs.

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