Where Does Your Salary Actually Go? A Simple Framework for Understanding Household Spending

A salary every month feels reassuring until it's almost over and you realize where all that money went!

The challenge for salaried employees is not in earning money; it's in juggling between rent, groceries, bills, subscriptions, family, EMIs, shopping, investments and more.

The good news is, you don't need to develop a complex financial system to understand your household's expenditure. There is a simple framework that can help you to divide your salary, build an emergency corpus and invest consistently without being unduly strict on your everyday needs.

A Simple Framework for Understanding Household Expenditure

Here's a simplified framework that can help you understand your expenditure:

Essential Expenses: The money you spend towards rent, groceries, electricity, transportation, phone bills and more

Lifestyle: The money you spend on eating-out, shopping, subscriptions and more

Savings: The money you save for emergency corpus, upcoming expenses, travel and more

Investments: The money you invest towards wealth creation, retirement, home purchase and more

The idea is to save before you spend from your salary and invest as soon as your salary lands in your account. However, you must also keep some room for flexibility since your expenditure can change from month to month, and also review your expenditures at the end of every month, and identify opportunities to cut down on expenses to channel more money towards savings and investments.

So your salary should be split between current needs, current wants and future protection.

Let's look at how this works out with a simple example.

Suppose You Earn Rs. 50,000 a Month as a Bachelor

Let's imagine a 25-30 year old bachelor who earns Rs. 50,000 per month after taxes.

He stays away from home, manages his own needs and wants to manage his lifestyle while building financial security. Instead of spending first and saving from the leftovers, he can allocate his salary as follows:

Step 1: First Rs. 22,000 Goes Towards Essentials

The first Rs. 22,000 in this example goes towards essentials.

Rent & Utilities — Rs. 12,000

Rent is likely to be one of the largest expenditures if you're staying on your own.

Keeping housing costs under control can have a significant impact on your ability to save money. Cohabiting or selecting a good location with good public transport can help you cut down both rent and commute costs.

Food & Groceries — Rs. 7,000

This amount can cover groceries, housekeeping needs and an occasional eating-out.

The idea isn't to restrict yourself to a barebones diet or never eating outside; however, you must set a limit for eating-out so that it doesn't stealthily drain your investment corpus. Similarly, groceries should be calculated so that you're able to have enough money to buy the essentials.

Transportation — Rs. 3,000

This can be allocated towards metro/bus fares or occasional cabs. The idea is to treat transportation as an expense rather than a limitless buffet of convenience.

Step 2: Rs. 5,000 Allocated Toward Lifestyle

Being a responsible adult doesn't mean you can't enjoy your salary.

Set aside Rs. 5,000 for discretionary spending. This can be spent on:

Movies
Restaurants
Shopping
Gaming
OTT subscriptions
Weekend outings
Hobbies
Coffee and more

Having a budget for discretionary spending can help you with budgeting actually because you can track your expenses better without feeling guilty that you've "gone overboard".

The money that is left in this budget can be transferred to your savings or investment account at the end of the month.

Step 3: Rs. 5,000 Every Month Towards Building an Emergency Corpus

A bachelor's first order of business before jumping into aggressive investments should be building a financial safety net.

Assuming that his essential monthly expenses are around Rs. 22,000, then a six-month emergency corpus would be around

Rs. 22,000 × 6 = Rs. 1,32,000

He doesn't need to build Rs. 1.32 lakh at one go. He can set aside Rs. 5,000 every month to build his emergency corpus:

6 months → Rs. 30,000
12 months → Rs. 60,000
18 months → Rs. 90,000
24 months → Rs. 1,20,000

At this rate, he'll have a six-month emergency corpus in roughly two years.

If his income is stable and he has good family backup, he may want to keep his emergency corpus smaller. If he has dependents or heavy loans, then he should consider building a bigger emergency corpus.

Where Should the Emergency Corpus Be Kept?

Your emergency corpus should be prioritized for liquidity and safety, and not for high returns. Keeping the money as per personal circumstances, it can be in:

• A savings account
• A fixed deposit at a suitable bank
• Or other liquid and secure instruments

The emergency corpus shouldn't be used for impulse shopping or vacations. It is meant to help you through genuine financial emergencies.

Step 4: Rs. 10,000 Every Month for Investments

Having allocated money towards essential expenses and emergency corpus, our bachelor now has Rs. 10,000 per month for his investments.

This marks the start of the long-term wealth creation journey.

Instead of trying to time the markets and figuring out what to invest in every month, he should come up with an investment plan. Here's what he should know about various investments.

1. Mutual Funds

Mutual funds are a popular investment route among Indians with varying levels of risk appetite. They allow you to put your money together with that of other investors, and let a fund manager decide how the money is invested according to the fund's mandate. While equity mutual funds can be a good long-term wealth creation tool for a young investor, they should be kept in mind that mutual funds are market-linked instruments and are subject to market risk.

For systematic investing, one can invest via a Systematic Investment Plan (SIP). An SIP lets an investor decide on a monthly amount that will be automatically invested towards a chosen mutual fund scheme.

For example, Rs. 6,000/month → SIP

The money can be systematically invested according to the SIP terms. The important thing to remember is that mutual funds are not a guaranteed-return product and their value fluctuates with the markets.

2. Index Funds

Index funds are an alternative to actively-managed mutual funds. Instead of a fund manager choosing what and when to invest, it tracks a stock market index and invests in a similar basket of stocks. For people whose investment horizon is longer than five years and who are looking to take on the risk of market volatility in exchange for higher returns, they can consider a broad-market index fund. For example, he can consider investing 1/3rd of his Rs. 10,000 monthly investments into a broad-market index fund for the Indian stock market. Again, it should be noted that equities are subject to market risk and shouldn't be considered for short-term needs.

3. Public Provident Fund (PPF)

PPF is a government-backed long-term savings scheme that can provide attractive returns with relatively low risk. In the case of an investor who is looking to build a conservative long-term investment component, PPF can be a viable option. As the name suggests, PPF has a long lock-in period (15 years). Therefore, it shouldn't be treated as an emergency corpus. The bachelor can consider PPF as part of his long-term financial planning needs while keeping separate contingency funds.

4. Fixed Deposits

Fixed deposits offered by banks can help conservative investors earn predictable returns with limited risk. These can be a good investment option for short-term and mid-term needs depending on the tenure. However, investing all your long-term money in fixed deposits may not be the best option if one is looking to protect against the erosion of purchasing power due to inflation over the long run.

5. Recurring Deposits

A recurring deposit can be helpful for building a corpus towards a specific need.

Instead of investing the full Rs. 5,000 short-term budget allocation into a liquid mutual fund account, he can consider a recurring deposit towards specific needs. For example:

Rs. 2,000 → Travel fund
Rs. 1,500 → Gadget fund
Rs. 1,000 → Festival/shopping fund
Rs. 500 → Other needs

He can use the appropriate product with the bank to fulfill these needs.

Step 5: Rs. 5,000 Towards Short-Term Needs

Not all goals need to be funded through long-term investment instruments. Our bachelor can keep aside another ₹5,000 for upcoming expenses such as:

Rs. 2,000 → Travel fund
Rs. 1,500 → Gadget fund
Rs. 1,000 → Festival/shopping fund
Rs. 500 → Other needs

At the end of a year, that's Rs. 5,000 × 12 = Rs. 60,000 that he can use towards his bigger purchases without having to rely on credit cards or EMI payments.

The most vital habit to build in your financial planning is to save and invest consistently instead of leaving it to chance

A fixed salary may provide you with a steady-income stream, but this should not restrain you from becoming more economically stable later in life

With intelligent spending habits and an emergency fund, along with smart investments, a monthly salary of Rs. 50,000 can help you secure your financial future.

Remember: Various investment products carry different degrees of risk/liqiuidity, tax implications, and overall returns. The examples given are for illustrative and educational purposes only and should not be considered as financial advice. Please consult with a certified financial advisor before making any investment decisions based on the information provided.