Income, Expenses, Investments and Savings

During a lunch break walk around the campus, we got into a discussion on the ideal allocation of salary across Expenses, Investments and Savings.

It was generally agreed that every year you must save at least 6 months of expenses you incurred during that year.

The reasoning was simple. Your investments, apart from your savings, will be a regular disciplined way of increasing your net worth. But if you suddenly need huge investment for say purchasing a house, then you need to dig into your savings. So unless you are saving every year, you wont be able to do this when you get the chance.

(btw, savings is basically liquid money, which is readily available at your disposal. SB accounts, Hard cash are savings. Investments are those which have a medium – long term asset appreciation time. Stocks, PF, PPF are investments. Also Insurance (all types) is an expense. ULIPs, ULPPs are stupid decisions that you made that should not be considered under any of these categories.)

So let the calculations begin!!
We have,

Where S is Savings, I is Income, E is Expense and INV is investments. Since you need to save as much as half your expenses

Substituting, we get

So in any case, you must not be spending more than two-thirds of your money. If you are spending upto 2/3rds of your salary, it either means, you are not investing for the future or you aren’t saving much, both of which aren’t good! Then you need other sources of income or you need to reduce your expenses.

A good thumb rule is: At least 30% of your income should be savings (because when banks decide your loan eligibility, they assume that percentage as your average savings. So if you aren’t saving that much, you might be given a loan that you cannot afford).

So a good mix of your Income should be:
60% Expenses – which indicates you are having fun.
30% savings – which indicate you don’t have to worry in case an emergency occurs.
10% investment – which indicates you have a good plan for the future.

If you are really having fun while spending less than 60% of the income per month, you must be doing better than the average indian household.

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