How can we save more in the same Income?

We all want to save more but we have limited resources, so how can we increase our savings in those resources only. In this post we will try to find out few simple tips which can be used to improve our overall savings.

1. Have a budget and follow it

We should have proper budget so that we can control the expenses within limits. Best way to do it is by fixing certain percentage of our income as saving and the remaining amount be spend or

Income - Savings = Expenses.

2. Nothing is free

We generally tend to spend more when using a credit or debit card, than when using cash. Similarly, we also treat a windfall income like a bonus and regular income like a salary differently. If we realise that the money spend by credit/ debit card will also go from our own income only and bonus is also hard-earned money, we may be more sensible while splurging this money.

One time cash flow can be invested through STP way which we have discussed in my last post (see the post How to invest large sum when market is at all time high?

3. Not Just Save but Keep on Increasing the Amount

It’s good to start saving but that is not enough. We should regularly increase the quantum of savings and investment. This can be done in line with the increase in income. In few cases like in EPF this increase happens automatically, as contributions to it is fixed as percentage of salary. However For other investment avenues, the onus of increasing contribution lies with the investor. By increasing the quantum of investments annually, we can reach to our goal faster or generate a bigger corpus.

As a thumb rule we should increase the amount by the rate of inflation. In mutual funds there are “Step-up SIPs  by which we can increase the SIP amount by certain amount or percentage  at a predefined time interval which can automatically increase our saving rate.

4. Saving is not enough, It should be invested properly

Once we have decided to save more and increase the quantum regularly, the next step is to route this savings into suitable investments. Few people are very good in saving but not good at investing. If we keep large amounts idling in savings accounts that generate 3.5% returns and in tax inefficient FDs then it is not a very sound investment strategy.

We need to overcome from loss aversion mentality, which occurs when the pain of losing money is greater than the happiness felt in gaining an equal amount. We need to understand that while keeping the money idle in bank accounts, assuming its safe we ignore the risk of inflation which ends up earning with 3.5% returns, actually lower than inflation. There are different instruments, suitable for different time period, like a cycle is good for 5 Km but not for 5000 Km equally an aeroplane is suitable for 5000 Km but not 5 Km. So we may take certain calculative risk and manage the risk in a way so as to improve our overall returns.

We should diversify our investment but also avoid overdiversification, have moderate return expectations and automating the investment process through long-term SIPs.

5. Keep a Watch and Rebalance it

It is also equally important to rebalance the portfolio based on our own requirements and market conditions. This rebalance can be between asset classes or between categories. Most people increase allocation when the market is doing well and reduce in a bear market. By Automating asset rebalancing, we can remove the biases and make it more efficient.

6. Stick to it; don’t divert the funds

Some time we start using the money earmarked for goals for other needs. We can avoid it by segregation of investments for specific goals, by this we can be clear how we are doing to achieve these specific goals.  We can stop from dipping into investments prematurely by opting for investments that restrict liquidity. Long-term lock-ins help improves the power of compounding. As the power of compounding is back-ended and the maximum benefits come in later years.

For short term and immediate requirements, emergency fund is a better way so as to not to digup from long term investment portfolios. This fund should be invested in a liquid instrument so that it is readily available.

For example, assuming a return of 12% P.a., If someone investing Rs. 5000/- monthly for 5 years will get Rs. 4.12 lakhs at the end of the period while if he continues the monthly investment for 20 years his total corpus could be almost Rs. 50 lakhs which is 12 times than five years corpus while investment amount has gone up by four times only.

These are few simple behavioural tips which can be used to improve our overall savings without putting much pressure on our spending habits, if used properly can give visible change in total portfolio.

How to invest large sum when market is at all time high?

We all understand Systematic Investment Plan or SIPs as they are generally know as to invest regularly. But what should we do if we want to invest a large sum and not so sure about the market, for those investors STPs could be the right answer to so as to spread risk over a period of time. Let’s understand it in more details.

Most of us understand SIPs which is the best way to invest in mutual funds especially for those who earn regular income i.e. salary and want to save in a disciplined way. SIPs is a systematic way of investments which works by setting up a regular, fixed investment every month or even could be weekly or quarterly. It gets you a buying price that is averaged over many months or years, which eventually enhances returns. It also protects us from falling market to some extent as SIP ends up buying more units for the same amount of money in falling process. Most importantly, in SIP the monthly or regular installment fits the income pattern that most people have.

However, many times people have lum sum money or they get due to some reason like bonus etc which is not regular but wants to invest that money also but in a much better way. If this money is meant for the long-term ( five years and above) it could be invested in an equity fund all in one go also. However, that carries the risk also, if the markets tank 10-20% soon after the investment we may lose a big chunk of our money and to recover the loss could also be long term affair. In this kind of situation may people would get panicked and redeem the entire sum.

So what could be the solution? 

The solution is simple, but many people are not aware of it, It is called Systematic Transfer Plan or STP, which effectively provides the same potential for higher returns and lower risk as SIPs do, but for onetime investments. The STP is a regular transfer of money from one fund to another. It's like an SIP but the source of the money, instead of being from our Bank Account, is another mutual fund.

So how is it better than lum sum investment?

In STP, initially the money is invested in debt funds i.e. Liquid/Ultra short term funds which have lowest risk and stable returns, and non-volatile. For example. Let's say we got Rs.20 lakh which we would like to invest in an equity fund. This could be an asset sales or bonus from an employer etc.  If we are investing the entire sum at one go, we are exposing the entire investment to any sudden decline in equity markets. Therefore, what we should do is to choose the equity fund(s) and then, choose a liquid/ultra short-term debt fund from the same mutual fund company. First we should invest the entire sum in the debt fund, and then instruct the fund company to transfer say, Rs. 1 lakh into the chosen equity fund every month. In 20 or 21 instalments (not 20, as the debt fund will also add some returns), all the money would have shifted to the equity fund. The buying price would be the average of that time period, thus insulating us from market fluctuations.

However we should always remember that STPs, like SIPs, are not foolproof. If we look back at the markets over the last 10-15 years, we will understand that while an STP generally helps one avoid a market peak and average costs, they're not a foolproof device. In a situation like 2003-2008 when markets keep rising for many years, and then fall sharply, then even an STP cannot eliminate losses. As we all know equity is volatile asset class and there's no way of doing away all risks. However, based on what has happened over the last two decades in India, stretching an investment over one to three years is likely to capture enough of a market cycle to significantly reduce risk.

How should we decide the period for STP?

That should depend on how significant is the sum of money in our overall assets. For example, If the money is  proceeds of a property sale on which some major future plan depends, then three- four years would be appropriate. On the other hand, if it's a bonus worth a few months' income, then maybe six months to one year is enough. There's no fix rule on period and it depends on what we feel is the risk.

To conclude, like SIP, STP can also help us to average out the risk which is inbuilt in the equity market. AS we all know equity market does not works in a simple line, it has short term and long term volatility based on may internal (micro) as well as external (macro) reasons. We can use different strategies to average out the risk however at the end of the day, So be ready for surprises by the market also.