In our previous blog, we wrote about how to live a balanced life – balancing priorities between today’s needs and wants while also focusing on future financial requirements, using the personal finance rule of the one-third.
We explained the thumb-rule of investing for retirement, an amount that’s at least as much as your essential expenses. The rule of one-third suggests dividing your income into three equal thirds between your needs, wants and retirement investments.
To understand this better, here is an illustration using our three favourite characters – Finn, Nancy and Meme.
Finn – as you will recall from our character sketch, is very conservative when it comes to personal finance. He invests far more than the suggested one-third for his retirement. In fact his retirement investment is double that of his essential expenses. During his younger years, If he invests a higher portion of this in equity than in fixed income instruments, he will be able to comfortably retire very early. But as you’d recall, Finn is conservative, so he invests all of this amount in fixed income instruments such as EPF, VPF, PPF, NPS, etc. However, since his investment is double that of essential expenses, he would still be able to beat inflation in the long-run and retire comfortably. On the other hand, he hasn’t allocated enough money for his wants. This may cause resentment in the family, for not ‘enjoying’ life as much as the neighbours and co-workers.
Nancy – as per her character sketch – is someone who focuses on living a luxurious life today by spending on expensive material goods (i.e., huge discretionary expenses). This doesn’t leave much for retirement investment except the mandatory employer-deductions for EPF (or NPS). Also, her total expenses are much higher than the total monthly income – this means she is running on a vicious cycle of debt fueled by credit cards and personal loans, which will eventually make her bankrupt. Forget retirement, no amount of money will ever be enough for such people, and they will always be on a borrowing and spending spree, never being content with what they have.
Meme – shows the ideal example – of having a balance between today’s needs and future investments, but also allocates enough money for discretionary expenses, thus keeping his family happy. He also ensures that his discretionary expenses don’t cross the threshold of one-third of income. This may mean tough decisions like traveling to Kashmir instead of Switzerland, or limiting the number of weekends when they eat out and cook at home more often. But that trade-off will help them retire comfortably, perhaps even earlier than normal.
Are you able to follow the rule of one-third in your life? How do these ratios look for your situation? Please let us know in the comments section below or on our social media handles.