Your annual savings rate changes significantly during your working life. In this article, we discuss the factors that necessitate such a change.

We also discuss how you can increase your savings without significantly impacting your current consumption.

Present vs future

You should have a disciplined approach to savings. Otherwise, you are unlikely to save and meet your life goals. Fortunately, technology has made it easy for you to save — via systematic investment plans (SIPs). Of course, how much you save is one of the biggest trade-offs in life.

You may have to sacrifice some of your current lifestyle if you want to save more today. Save less today, and you may be unable to fulfil your life goals.

You have to, therefore, vary your savings rate through your working life to achieve your life goals. Why?

For one, your free cash flows change during your working life. By free cash flows, we mean post-tax cash flows that are available to meet your savings and current spending after setting aside money for loan repayments.

Consider this. You are likely to buy a house on mortgage after you start working. This is likely to consume 40 per cent of your post-tax monthly income. Then, there is your child’s college education. Add other lifestyle needs to that, and a good part of your post-tax monthly income is used for funding such borrowings till the age of 45. Fortunately, your borrowings reduce as you age. Why? You will significantly pay down your mortgage by the time you turn 45.

Now, there are two sides to your free cash flows — your inflows and your outflows. Your inflows increase as you age — your income levels rise exponentially as you approach retirement. Add to this the fact that your outflows reduce as you cross 45 and your free cash flows increase substantially on your way to retirement.

The second reason your savings will change during your working life has to do with the fact that your risk appetite will reduce as you approach retirement. You will, therefore, want less of risky assets (equity) and more of stable assets (bonds) in your portfolio as you age. And that means you have to increase you savings to bridge shortfall in returns, because the expected returns on bonds are lower than that on equity.

Forward SIPs

Increasing your savings can, however, hurt your current lifestyle. So, what should you do? For one, you can channel cash flows that were earlier used for paying liabilities. Suppose, you are paying ₹50,000 as EMI on your mortgage. You should set up an SIP for ₹50,000 just as your mortgage is due for completion.

That way, you can prevent the free cash flows released from the mortgage from forming part of your regular spending. Instead, you can invest the money to accumulate wealth. For another, you should set up a forward SIP each year around the time your performance review and salary hike are due. Why?

You can increase your savings by setting aside about 30 per cent of your incremental salary in addition to your regular savings without hurting your current lifestyle.

The objective is to increase savings through your working life without causing a significant impact on your current lifestyle.

Typically, your savings rate should increase from 10-15 per cent when you start working to about 50 per cent when you approach retirement. Fortunately, your career progression (income levels) typically balances your genetic code (change in risk behaviour) to facilitate your savings trajectory.

The author is founder of Navera Consulting. Send your feedback to portfolioideas@thehindu.co.in

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