Smart saving goes beyond putting occasional extra money into an earmarked account. It also entails not committing silly blunders. Here are some common mistakes that could throw you off course.
#1: Not stepping up your savings rate as your income increases.
A painless way to increase your savings is to make sure that as you get raises, you are actually setting additional amounts aside. It’s a great way to build your overall wealth. Let’s say you set aside Rs 2,500 which is invested every month into two mutual funds. You do this when your earnings are Rs 50,000, which translates into a savings of 5%. Should your salary go up to Rs 60,000, it would be foolish to keep the amount you invest constant. Instead, stick to saving at least 5% of your earnings – which would translate to Rs 3,000.
#2: Not keeping an eye on your standard of living.
With increments and (hopefully) more savings, consumption too goes up. A strategy that says ‘I'm going to keep saving 20% of my income’ also means that you are going to spend 80% of it. The fallout of such a tactic is that your standard of living rises so quickly that your savings actually lose pace.
The problem is, when one raises their standard of living, not only do they increase their spending, they generally lift how much they are going to be spending for the rest of their life. So every increase in their spending is an increase they are going to have to fund for 30 years of retirement.
Financial planning expert Michael Kitces suggests an alternative to the idea of saving 20% of your income: instead of focusing on how much of income is saved, focus on how much of the raise is spent.
Give yourself permission to spend 50% of every raise that you get going forward. It's a pretty good number. You are going to feel like you are getting wealthier and you are spending more every year. But what actually happens over time is, if you merely spend 50% of every raise, you are implicitly saving 50% of every raise.
#3: Investing too conservatively for your time horizon.
For people who are decades away from retirement, they cannot afford to shirk equity. Their portfolio must be predominantly invested in stocks and only as they get closer to their retirement age should it tip more into safer securities.
Investors are often told to pay attention to their risk tolerance when allocating assets. That is sound advice. However, that does not mean volatility can be completely bypassed. There will be volatility in a market-linked instrument and it should not upset investors. In fact, they must learn to live with it. The rewards will be evident over the long term when the returns outpace inflation and result in wealth creation.
#4: Making investments based on recent performance.
One thing we often see is that investors tend to want to drive with the rearview mirror. So they look at whatever has performed best in the recent past and they decide that's where they want to put all their money. Oftentimes that is the category that is the most highly valued. So the security prices have already enjoyed a strong run-up or perhaps it just has a lot of risk baked into the asset class.
Shopping based on past returns is often not a good idea. You really do need to think about the fundamentals of the investment, think about its risk reward characteristics, think about, if you're investing in some sort of a fund, product, think about the types of investments that are in that fund, and think about whether they are attractive or not.
#5: Ignoring fees.
Ignoring fees is a mistake that we see investors oftentimes making when managing their portfolios. And those fees, even though they seem small and innocuous, because there are expressed usually in just percentage terms, they might look like they won't be a big deal. But over time, if you're invested for a period of , say, 10 or 20 years, the difference between a low expense fund and one that charges maybe twice as much, is very substantial in terms of your take-home returns. So do comparisons. Generally speaking, you're better off sticking with the product that has the lower expenses attached to it.
It's not the only driver of your investment but one of the few quantifiable drivers of investment results. So, you do need to pay attention to it.
Along the same lines, don’t be too quick to exit funds. Even if you have made a wrong choice, stop fresh investments but sell your units when you can avoid short term capital gains. Expenses, taxes and inflation are what eat into your savings and you need to combat them as best as you can.
