Time to rethink your spending!

Why does the younger generation easily spend on experiences but hesitate to invest?

It's simply a matter of their whole life experiences. They are a more confident generation that is more sure of themselves. When you're a little unsure of your financial future, then you'll worry about it, following which you'll plan for it.

Also, the spending avenues have grown. Now you have Blinkit, Zepto, Zomato, Amazon, Flipkart, etc. Everything is just a click away with speedy delivery.

Suggested read: Zomato's new blood has investors upbeat. Will it be the final game-changer?

Due to the provision of EMIs, it has become easier to make big-ticket purchases. For instance, if you want to purchase an iPhone but don't have the money to shell out for the full price. While an EMI of Rs 8,500 over a period of five years seems like a reasonable deal, you get stuck on this EMI. And it leaves little room for other expenditures.

You can even borrow to spend. No one is stopping you from spending, of course. You can even mortgage your income to spend more and more. But if you're doing it for something unnecessary, you might regret it. On the other hand, if you are certain about your flow of income, then you'll have less regrets.

The real reason behind this avid spending is that people have too many needs and desires that can be fulfilled easily due to friendlier payment mechanisms and online shopping. This is also a time when you have lower resources - you're just starting out, so you earn less. Suppose, you need to buy a bike or want to go on a vacation, most of your money is consumed in these essentials. So, you don't form the habit of saving.

Forming that habit, I think, is the most important aspect. Because at this point in your life, you're living on a tight budget, and you think, "Once I have a surplus and a meaningful level of savings, I'll start investing."

This leads to procrastination. Investment is a matter of habit. If you don't start small, you'll keep waiting for when you'll have more. But you'll never have that 'big' amount. Instead the small contributions will add up to something significant. And this is where the magic of compounding kicks in. People don't appreciate how impactful small sums can be. It takes five to ten years for it to become meaningful, and during that time, many people think, "I'll deal with it later." Procrastination is a big issue. When you're just starting, it's a small amount, and you justify to yourself that it's too small to matter, so the habit never forms.

How does the power of compounding work?

It takes five to ten years to appreciate the power of compounding. Go to Value Research Online and use the SIP calculator. While it makes some assumptions, if you contribute Rs 10,000 a month for 20 years, it becomes significant. After 20 years, Rs 10,000 a month at 12 per cent return (lower than what the Nifty or Sensex has generated) becomes Rs 92 lakh. Add one more year, and Rs 92 lakh becomes Rs 1.04 crore. Compounding at 12 per cent on that large capital turns Rs 1.04 crore into Rs 1.18 crore. While your single-year contribution was Rs 1.2 lakh, the growth on your principal is about Rs 17 lakh. That's the magic. Once you experience it, you start to appreciate it, and you resist the temptation to fiddle with it. But for this to happen, you need to be very disciplined during the first 10-15 years. That's when it becomes visible, and you'll have a capital sum you never imagined. Once it grows, primarily through equity, then you start appreciating the magic. So, it is essential to start early. Without starting, it's wishful thinking, not a strategy.

What strategies can one use to balance enjoying their current lifestyle while investing for the future?

I think it's important to be able to spend on essential things - you can't do without them. That's why you earn. Second, think about the non-essential but important expenditures you need to make. It could be buying or upgrading a car, something which is essential for your job. I don't think that's wasteful, nor is it frivolous spending. Third, make sure you allocate some of your budget for future security. You're postponing some consumption for long-term funds, and that's crucial. It's all about being prudent.

If you borrow today to spend on something unproductive that won't grow in value, that's dangerous. In emergencies, borrowing is understandable, but borrowing to consume is risky. Once you fall into that habit, it can be a struggle to get out of it. Even companies struggle to get out of that habit. And the only way out is bankruptcy, and the same could happen to individuals. You need to strike a balance. Besides that, there's one more avenue: work towards growing your income. That can ease your financial stress.

Viewer's question:

It is usually said that the magic of compounding starts to appear in your mutual fund portfolio once the valuation touches Rs 1 crore. But does it hold true for the entire portfolio of 12-15 funds altogether or just a single fund? - Kunaal

It's valid for all of it. If you're holding 15 good funds and these funds beat the benchmark over five years, there's a likelihood you'll benefit from them collectively. In these 15 funds, over a 10-year period, some will yield 12 per cent and others 24 per cent. All of this averages out. Think of two or three small-cap funds, a few large-cap funds, flexi-cap funds, and mid-cap or value funds. These funds perform differently at different times, but together, they help you generate good returns. Diversification is key because you can't expect all to be blockbuster performers. So, it's important to diversify across styles and funds. If you have eight, 10, or 12 funds, that's fine. Just make sure they're good ones. Don't let the underperformers dominate your portfolio for too long.

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Also read:
Spending and saving on the internet
An anti-savings culture
Perfection is the enemy

This article was originally published on October 18, 2024.