Here are simple ways to check if you are spending too much. Money is meant to be spent .. sooner or later. Sometimes we spend because we want to and sometimes because we need to. Money spent sooner will affect our ability to spend as we much need to or want to later. It might help to put a red, amber and green kind of perspective on the spending process.
How much are you spending per year?
Exclude EMIs and other liabilities. Exclude expenses that will not last beyond a few years. Include only those expenses that will persist as long as you or your spouse. Call this Mexp (mandatory expenses).
Method 1: Determine, using the calculator available in this post, Should You Invest For Retirement as Much as You Spend?, what percentage of Mexp should you investment per month for retirement.
Here is an example: Consider a 25-year-old who wishes to work for the next 25 years. Assuming the inflation to be 8% and that his portfolio will beat that by 4% (portfolio return after tax = 12% is unrealistic, used just to point the high savings required even for this situation). And assuming his salary (and investment capacity) will grow at the rate of inflation (again not realistic, but same reason as above)
About 50% of Mexp has to be invested each month. This number is independent of what Mexp is! Now if you put in more realistic values, the monthly investment needed will only increase.
If the amount to be invested sounds too much, then for reasons good or bad, you are spending too much.
Method 2: This gives you a different sense of perspective and may not be as direct as the one above.
Step a: What is your current tax slab?
Step b: Suppose your net taxable annual income were to reduce to Mexp today, how much tax would you have to pay?
Step c: What is the difference between the answer to step 1 and step 3?
Suppose current tax slab = 20% and tax slab with Mexp as income = 20% would typically mean things are tight. It could mean that you are spending too much.
Both slabs being 10% is unlikely. If both slabs are 30% then I hope you will need to validate again with the first method!
Generally, if tax slab with Mexp as income is one step lower then current tax slab, it is most likely a healthy sign wrt spending and investment.
If tax slab with Mexp as is income (eg. 10%) is two steps lower than current tax slab ((eg. 30%), it could mean a frugal lifestyle.
Of course this a very rough indicator. The main aim is to estimate the tax slab after retirement (and how best to reduce it – more later). Some of my earlier retirement calculators included this logic. Somehow I did not continue it in the latter ones: Online version of the low-stress retirement calculator.
Over to you
Do these methods make sense? If so, please give them a shot. If not, let me know why.
Connect with us on social media
- Twitter @freefincal
- Subscribe to our Youtube Videos
- Posts feed via: Feedburner
- We are also on Google PlusandPinterest
Do check out my books
You Can Be Rich Too with Goal-Based Investing
My first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create customg solutions for your lifestye!Get it now. It is also available in Kindle format.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
My second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a youngearnerThe ultimate guide to travel by Pranav Surya
This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for ₹199 (instant download)Create a "from start to finish" financial plan with this free robo advisory software template
Free Apps for your Android Phone
All calculators from our book, “You can be Rich Too” are now available on Google Play!Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)
