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Why It is Important to Maintain an Appropriate Savings Ratio
March 13 , 2013

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.

Need for 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 cut down a bit here and there. Since we are talking long term, say 15-20 years away, even small cut-downs can add a lot more than you would imagine.

If you happen to be one of those who think that in your situation getting to the ideal savings rate is next to impossible, think again. There are many practical ways of cutting down on spending without losing the fun of spending.

For instance buying groceries and other provisions in bulk can make much difference. Making use of public transport or better still walking (depending on distance, of course) instead of private vehicle will be good for your purse, health and the atmosphere as well!

You might find it useful to remember the distinction between saving and spending- though it might sound like a silly thing. But sometimes it's difficult to distinguish - what is buying a house? What about buying a car? The latest model LED TV? 

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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