Do you want a Ford Ikon or a Mercedes?
I would think that the answer is obvious. But the big question in your mind will be: How?
The issue, as always is, there is a catch -- and interestingly, the catch is more philosophical than financial. Hence, before we answer this question, let us appreciate the different philosophies of running your personal finances.
Ours traditionally has been a 'save today, consume tomorrow' philosophy. Indians have tended to believe that a rupee saved is a rupee earned, and that saving for a rainy day is judicious. Western philosophy, however, demands immediate gratification: what you are is what you consume.
The objective of this article is not to critique the philosophies but is to point out that choosing one over the other can have profound implications in your lifestyle and wealth building. There is no value judgment in this article, but each of us have to choose which philosophy suits us best.
Buy a Ford Ikon today:
Let us say you are concerned about your commuting needs and you consider buying a car for yourself. You have only Rs 1 lakh (Rs 100,000) in your savings bank account, which you want to use to purchase the car.
If you buy a Ford Ikon today, it will cost you let us say Rs 6 lakh (Rs 600,000). You will possibly take a loan of Rs 5 lakh (Rs 500,000).
Now, given the present interest rate scenario, you might find an auto loan at around 12% interest, which works out to an EMI of Rs 11,122 per month for 60 months (5 years).
At the end of five years, you will have paid off the loan, but your Ikon too would demand a replacement: it would now be too old (and outdated?) for your running. Hence, at the end of 5 years, you have no loan and no asset -- you are back to the same position that you start today with and no Rs 1 lakh in the bank account also.
You will now need to look for funding for the new car again.
"Wait!" I hear you saying. "I have used the car for the five years and derived pleasure and comfort from the same. If I did not have a car, I would have either gone in the train (oh! and the dread of Mumbai local trains!) or would have taxied to office (which is exorbitant)."
My hunch is, many would, given no choice of a self driven car, have chosen a public mode of transport and hence the cost of commute would be similar to the running expenses of the car.
Your fuel and insurance expenses would have financed your commute expenses. But, what I cannot deny is the vastly different pleasure that you derive from coming to work in a car, as compared to a crowded train!
Buy a Mercedes five years from now:
If you push back consumption, you will (hopefully!) save -- and invest. Now, the money is working for you and not for the bank.
Carrying forward the example above, if instead of paying the lump sum of Rs 1 lakh today and the 60-month EMI of Rs 11,122, you invest the same, then, at the same rates of interest (12%), it will grow to Rs 10 lakh (Rs 1 million) in five years.
"Stop right there! You have not accounted for the demon of financial planning: inflation." Yes, you have a very strong point there. Assuming a 6% inflation rate, this still means that the Rs 10 lakh that you will have then will still carry as much purchasing power as today's Rs 7.5 lakh (Rs 750,000).
So let us review the situation after five years under this scenario: you have no car (same as the previous case) but now you have Rs 10 lakh with you. This Rs 10 lakh can finance a very substantial portion of your Mercedes -- and if you do decide to buy a car, it will last you five more years. (However, following this philosophy, whether you will ever buy a depreciating/consumption asset, is something to ponder about!)
To upgrade from your Ford Ikon to Mercedes, you have had to do two things very regularly:
- Travel in a public transport for five years, and
- Be disciplined about your savings and investments.
What it helps you achieve is that your money works for you and not for the financier.
Which road should I follow?
As we said earlier, the objective of this article is not to side with one philosophy or the other -- or the growing importance of one over the other. Enjoying an upgraded lifestyle can be, and is, for a lot of people more important than building wealth ('why else am I saving anyway?')
However, it is for you to know which path you are following and the reasons for following that path.
The author is Director, PARK Financial Advisors, Mumbai. He is an Indian Institute of Management-Ahmedabad alumnus. He can be reached at info@parkfa.com
