Spending seems natural whereas saving appears to be a forced habit. Here, we discuss the primary reason why saving for the future is behaviourally difficult. We also show how systematic investment plans (SIPs) help us address this issue.

Present happiness

Our primary goal is to improve our (financial) well-being. All decisions we take are geared towards increasing pleasure or reducing pain, as this is the optimal way to improve our well-being. It is in this context you must consider spending and savings habits.

Spending on products and services today gives us immediate happiness. Saving today can provide happiness in the future. But saving is likely to cause pain today because you must spend less today to save for the future. Also, happiness in the future depends on how skillful and lucky you are with your investments, as the outcome of your savings decision is uncertain.

Also read: Funds that made ₹25,000 p.m SIP into ₹1 crore in 10 years

Suppose you save continually to make a down payment for a house in the future. Your investment may not generate the required return to achieve the goal. Or your investment may generate the desired return, but housing inflation could push up property prices.

Therefore, the amount you accumulate in your investment account may not be enough to make the down payment. You understand the uncertainty of the outcome. Your brain, therefore, battles between present and future happiness, and the former mostly triumphs over the latter. Small wonder we are biased towards spending. Online shopping and electronic payments have only made it easier for us to spend.

There is an optimal way to spend and save. You must set aside savings first through SIPs (auto-debits to bank account) and then spend the rest from your post-tax monthly income.

Conclusion

All of us desire to continually improve our well-being. So, it is tempting to increase spending. But, it is more important to increase savings every year. This is because you must reduce equity investments in your goal-based portfolio to reduce the risk of losses as your approach the end of the time horizon for a life goal.

Also read: Financial planning: Insurance or investment?

Because bond investments earn lower returns, you must save more in bonds to match the higher expected return on equity investments.

These higher savings must come from the incremental increase in your monthly income every year. Therefore, increase your SIP amount every year and spend only the rest of the increase in your annual income.

(The author offers training programs for individuals to manage their personal investments)

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