We had discussed about how much you should save for your retirement in this column dated July 22, 2012. Our suggestion was that you should concentrate on controlling your spending and invest the rest of your income to achieve your investment objectives. Continuing on this topic, we discuss two factors, your income and your spending decisions, that can improve your retirement wealth.

Enhancing income

By now, you know that you possess two assets — investment capital and human capital. Investment capital is the sum total of your savings and growth in savings. Human capital is the present value of all your future income.

You can retire rich if you can increase your human capital. And you can increase your human capital by investing in higher education. But pursuing higher education calls for trade-offs.

For one, your income will stop during this period and, therefore, your savings. For another, you will have to withdraw money from your existing investment account to support your monthly expenses. So, pursuing higher education could significantly deplete your investment capital. The risk is high, for there is no guarantee that you will get a high-paying job after you complete your higher education.

And that is not all. Even if you get a high-paying job, you may not retire rich! Remember, expenditure rises to meet income. So, if you are not careful with your finances, the growth in your spending can be much more than the growth in your income. And this could cause problems for you. Why?

By the time you retire, you will be accustomed to a higher standard of living. But your savings may not be enough to support this higher standard of living after you retire. Why? You need to save a significant proportion of your income to bridge the gap in your investment capital caused by your pursuit for higher education. Can you?

Spending decisions

Your ability to retire comfortably primarily rests on your spending decisions. Most of you typically save 10-15 per cent of your monthly income. That is, indeed, a good way to start your savings process. But you should also increase the proportion of your savings as you improve your income levels to bridge the gap in your investment capital.

Suppose you save 15 per cent of your monthly income and expect an increase of 20 per cent in your salary next year. You should decide today to set aside at least 30 per cent of your incremental salary besides saving 15 per cent of your total salary. Importantly, you should set-up a process that will automatically transfer this amount from your salary account to an investment account.

Not only that, you should also consciously control your standard of living. To do so, you should first divide your expenses into three- non-discretionary, semi-discretionary and discretionary.

Non-discretionary expenses include food, health-care and home. Semi-discretionary includes transportation, clothing and small comforts such as eating out. Discretionary includes costly vacations, giving gifts and expensive hobbies.

You should take care to control your discretionary expenses and your semi-discretionary expenses, especially the latter. If you do not control your semi-discretionary expenses, this class of expenses (expensive clothing and fine dining, for instance) will eventually become non-discretionary!

That is, you will get used to spending regularly on expensive clothing and fine dining. And this can be a cause for concern, at least till the early part of our retirement years.

Make choices early

The strategy to increase human capital works well if you are between 27 and 32. You should, however, be careful with your spending decisions to make this strategy work.

Make your choices early if you wish to enjoy a comfortable post-retirement lifestyle.


Two factors that determine whether you can retire comfortably are your income and your spending decisions.


(This article was published in the Business Line print edition dated September 2, 2012)
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