Monday, February 23, 2009

Our focus - Incomes less Expenses

This magic equation never fails. This is the ultimate truth of our financial well being


Incomes less Expenses = Resultant Surplus.


At the end any surplus money that we have in hand is always the result of our incomes exceeding our expenses. Some may say that they do have money in hand but that comes from borrowing. This series of posts have not taken “borrowings” as a means of cash inflow. I have stuck to “conventional wisdom” or a “conservative approach” if you will.


These resultant surpluses do not automatically become savings. These have to be managed for them to become savings. A person or family having a surplus could


- Save and invest, or

- Spend the surplus away on consumption, or

- Use this for asset acquisition, or

- Prepay debts taken earlier for any purpose.


Each person / family would, presumably, choose any of the above options in their best interest and depending on their financial position. I am referring to option -2 above. It is not necessarily irrational to choose spending especially if surpluses have been adequately put aside and built-up in the past.


We eventually need to build our understanding on how to manage our surpluses. This is in essence the core of “Financial Literacy”.


A note on borrowings:


Easy borrowings to facilitate spending, fortunately has not been a part of the larger Indian psyche. It did make its presence felt mainly in urban areas and amongst youth but thankfully has been a restricted phenomenon. The growth rates in “loan products” has seen a phenomenal rise in the past decade or so but the absolute figures still seem in control.


Borrowings, however, have been accepted as a norm to finance asset acquisitions like buying a house or car or some other assets. The best part is such borrowings never run their full course. People tend to pre-pay their loans and be debt-free. A normal fifteen year home loan has an average life of just seven – eight years.


This shows the general aversion of an average Indian to carry debt in his name and a sense of shame attached to inability to repay or repossession of the asset acquired out of that debt.


I also think, the spectre of slowdown, job losses and loss of confidence in sustainability of one’s income flow has in the recent past slammed the brakes hard on free spending. One can sense a general tightening of belts and postponing non-essential expenditure.


Some interesting links for those interested in further reading:

  1. http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4105
  2. http://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=198
  3. http://www.mydigitalfc.com/personal-finance/indian-consumers-turn-debt-averse-survey-595

We shall examine the basic principles of money management and how our surplus money may be handled.

11 comments:

Vinod_Sharma said...

Again very lucidly presented. I think the reluctance of Indians to borrow stems from a history of very high rates of interest that traditional lenders charged often with disastrous consequences fro the borrowers. Now things are different and better regulated. Should we still continue to harbour the same apprehensions? Or is it better to prudently increase the "borrowing" component? Also is it wise to prepay housing loan if yo are getting tax breaks?

manju said...

Nice discussion about surpluses.

It must be easier for a salaried person to calculate and decide how to invest surpluses, than for a professional or trader with no fixed income.

Indyeah said...

This is a very well written post sir:)
completely understandable to a lay person like me..

Thats a rather interesting reason Vinod Sir has given..
and yes,traditionally I do think we are a nation of hoarders traditionally.
uptil now I have sen all the loans taken by my family or by family friends being repaid before time..

But now I see the new generation early 20s barely out of school and college and they take huge loans for cars and houses because they get jobs so quickly..
and they are very careless about repaying it back on time...so I think the new young 'urban'Indian is going in a different direction..I hope it doesnt hapen though because the US seems to be in such dire straits where people are knee deep in debt and use their multiple credit cards for everything from a pin to a car to a home...I hope we dont go that way...

Mavin said...

Hi Vinod,

If you calculate the tax breaks save you 33.99% tax but set you back in liquidity terms by 100% (the quantum of interest that you pay).

So if you can pay Rs. 33.99 and have additional cash of Rs. 66.01 in your pockets - you might opt for it.

Further, if you have had a bounty, you can pre-pay a chunk and reduce your monthly EMIs thus helping you lead a slightly better life.

It is a matter of choice.

Mavin said...

Manju,

A business person without a fixed flow of income can plan savings as if it was an expense committment.

At a later stage when he gets large incomes, he can also top up on these savings.

Mavin said...

Hi Indyeah,

You are right - the 20 somethings with a large income and no responsibilities have begun to spend freely and maybe even recklessly.

I guess this will all come to a screechy halt what with the slowdown, salary cuts and job losses.

The main problem of USA has been spending beyond their means.

Mavin said...

Vinod,

Just to add - Our bitter memories of dealing with money lenders and the horror stories of their recovery tactics must be playing a role.

However, traditional life and conventional wisdom worshipped frugality. Living within our means was not a cliche but a way of life.
Loans were also not available easily.

I think it has been more a case of our cultural moorings. Obviously, people disagreed with "Charwak".

Indian Home Maker said...

I agree Mavin!

Even given a choice between buying a house or a car, most Indians will first choose a house, which can become a future source of income (or saving of rent).
A car is not a source of income but remains a popular reason for borrowing :)

I agree we are generally money-wise.. we remain sensible. Even if there are borrowings, the goal is building of assets, though this might back fire sometimes!

Instead of pre-paying a borrowed sum, is it not a good idea to just keep the money as ready liquidity and continue repaying EMIs as planned?
Just wondering because repaying might mean being left with no debt but also with no readily available cash ... What do you think Mavin?

Also most Indians have a fear of credit and credit cards :)

the twenty second line said...

now america is trying to promote " living within our means"

getting loans are becoming tougher - that also means the cycle of consumption is reducing and thereby one of the reasons for economy to pick up more difficult.

it is like the japanese who went into forced less consumption after the bump in the economy - that prevented them in raging again.

anrosh

Mavin said...

Hi IHM

Had replied to yor comment but I notice it is not there. Maybe the absent minded me did not save it.

Pre-paying a loan is an option many people adopt just to be free from debt. But it all depends on each individual family.

Let me see if I can write a small post on just this particular point.

Mavin said...

Hi Anrosh,

We in India largely grew up in scarcity and therefore every rupee was spent after much thought and deliberation.

Therefore, living within one's means was de-rigeur and not very difficult for most of us.

Yes America is now dicovering this. We Indians have always been living that way.

It is going to be difficult for the yanks as becoming austere after a life time of wastefl consumption is almost similar to third degree torture.