Consumption smoothing: How to save money while spending it by Priya Sunder

With a savings rate of around 30%, Indians are one of the highest savers in the world. From the time we earn our first paycheck, everyone, from our parents to our banks, tells us to save for the future. Often, current desires are pushed to the future, so we can accumulate wealth for our retirement. Is it only then that we should take fabulous holidays, drive a BMW and live life to the fullest?

What if you are 60 and wealthy, but not in the best of health? Can you really enjoy the fruits of your labour? Will you not wonder about the opportunities you passed up in your younger days because you chose saving over spending? I meet many people from an older generation who wish they had access to their current wealth when they were younger.

Financial planners refer to the concept of consumption smoothing, where your goal is to maintain a good and steadily growing standard of living throughout your life. You do not want to spend all your money in your thirties, then constantly play catch up for the rest of your working years, and lead your retirement in penury. However, just like excessive spending is not desirable, neither is excessive saving. You do not want to lead an overly thrifty youth, only to be exceedingly wealthy in your old age. You want your consumption pattern to be smooth throughout your life.

One of the greatest causes of fear and guilt around spending comes from not knowing how much you need to ensure a comfortable life for yourself and your loved ones. During your working years, think of yourself as a money machine. You generate cash flows that you expect to continue till you retire. Your hesitation in spending today stems from the fact that you are uncertain about the future What if this machine breaks down during its productive period? Life also throws curveballs at us every now and then in the form of medical emergencies, loss of job, unexpected home expenditures etc. Sudden cash outflows can put your financial independence at risk and delay your financial goals significantly.

Effective money management is about making the right choices early on. Mathematical modelling is critical to creating a financial plan that will make the appropriate provisions for the future, balance out saving and spending, and ensure that your financial plan is flexible enough to handle any roadblocks life throws at you. You should discard those irrelevant rules-of-thumb and work out your retirement needs in a more scientific manner.

Working with a capable financial planner, you can project the future fairly accurately, based on your current assets, income and expense patterns. You can identify the risks associated with any disruption to your income flow between now and retirement. You can estimate quite precisely how much money you need to retire comfortably, assess your current net worth and create a plan for how you can cover the shortfall.

Once you know how much you need to set aside for the future, you can spend the money today doing the things you enjoy instead of pushing it to later, when you are too old to enjoy them. This does not mean that you indiscriminately spend money. I am talking about responsible spending where you are in control of your expenses, else you’ll end up borrowing way more than you can sustain, ringing up huge debts and depleting your wealth faster than you generate it.

After meeting your essential expenses such as food, rent, EMIs and school fees, you also need to put away some money each month towards major future goals such as children’s higher education and marriage or buying a home. Once both of these have been done, you know that your current expenses and future goals have been covered. The money that is left over has no other claim on it, and can be spent in upgrading your lifestyle.

Many of my customers seem well placed for a very comfortable retirement in which they will not have to depend on anyone else for the financial needs. Not only are they likely to be financially independent, they are also likely to leave their children a very healthy estate in terms of assets. If leaving behind a lot of money for their children is their objective, all is well. However, we come across more and more parents who would want to give their children a good education and also leave behind some wealth, but certainly not a vast proportion of their assets. I advise such customers to improve their current lifestyle after ensuring that risks associated with life, medical and income are adequately addressed in the plan.

Any financial planner knows that ensuring financial independence is Job #1. But the best financial planners go beyond that and help you achieve a better lifestyle, by advising you not only on how to increase your wealth, but also on how to enjoy your life to your fullest potential.

So go ahead, plan that vacation in Europe, eat out more often in star restaurants, buy gold class tickets to a movie, or buy your wife the solitaire she’s wanted for the longest time. It won’t break the bank, and it won’t ruin your financial future. For all those who say money can’t buy happiness, I disagree. Money can buy you comfort, security and satisfaction.

It allows you the ability to not only spend on yourself, it also allows you to spend on others and contribute to society. In fact the paradox of money is just that. Money makes us happy by enhancing our prosperity. But it makes us happier when we give it away to make a difference in someone else’s life.