What if one does not save at all? This is the question a reader asked me after reading one of my recent columns about youngsters and savings. Is it mandatory to save? What happens if there is no saving?This is quite like the Finance 101 question on leverage. When we teach new students the financial structure of a business and point out the benefits of lending, it suddenly seems like a business needs no money of its own. What if it was funded completely with borrowed money? One can then make profits without investing any capital. This is technically possible only if the firm has no risks to its profits, and if it always makes a return on capital that is higher than its cost of borrowing.That did sound like a Finance 101 classroom. However, the connection to our question is simple. If there is no risk to income, and if the income always covered the expenses, there is no need to save. We save because we worry about risks to income. Someone with enough wealth to provide for expenses all through their lifetime will not consider savings as an option.But for most of us, both situations are real: our income may come under risk. Or may come to an end on retirement. Our expenses may unexpectedly shoot up. Or a sudden expense that is bigger than the routine income may come up. In either case, we need savings to fall back on. We save because we care about these risks.What if there was a pension income that steadily flowed in from the government or the erstwhile public sector employer? What if that income was also inflation indexed to provide for a revised dearness allowance linked to prices? Would such a pensioner need to save?The steady income is a good thing to have. But unexpected expenses are still an uncontrolled item. If the pensioner had a corpus to fall back on, or a reliable support from his children who are willing to fund such contingencies, the pensioner can spend all his or her income and not care for savings.But they may still save for the psychological satisfaction, even if none of the uncertainties played out. Regret is an emotion many do not wish to experience. To save is to preempt the sharp regret one feels when an unexpected event requires an amount of money one is unable to garner. To think about the earlier indulgences and failure to save, can fill one with regret. Conservative spending and habitual savings are both preventative responses to this possibility. Many save even if they don’t have to.There was a friend of mine who did not save a penny. But he lived a different kind of life. He gave away a good part of his income to charity; he acquired no assets; he did not marry or raise a family; he lived a remarkably minimalistic life. He believed that there is no need to set money aside and that life would take care of itself day to day. He lived and passed with that philosophy. Not many of us would have the courage to live such a life. We nurse our fears and apprehensions and we save.Is there no real cause to save for? Are we all saving because we worry, we fear, we anticipate or we control? We also save because we accept the rational order that we may not know the future with accuracy. We save because we understand that even the best forecasts cannot account for events that are yet to take place. Our response to the likelihood of the unknown events is to be prepared for it, as if it would happen, dismissing any low probability that may be attached to it. We do so because we are all risk averse.There still is a good reason to save, coming from the humility that we do not know the future. But we may be willing to make assumptions that help us deal with that uncertainty. In our early days of earning, we saved meticulously for the higher education of the children. Setting aside portions of the then-limited small incomes for the future was tough. It involved giving up some of the luxuries that money could have paid for.But as the children grew older, we moved up the income ladder. By the time the children went to college, we were able to pay the fees out of our regular annual income. Was it a foolish decision to save for a purpose that seemed to be easy to fund when it arose?Looking back at the 18 long years of saving and sacrifice, it seemed that we had been truly conservative. But how could one have guessed in the 1980s when we began to work, that a liberalised India would come about? Or that the joblessness and despair that engulfed college degree earners of our times would become a thing of the past? We had no tools to trust that our incomes would rise as they did, with the new economic opportunities.We save not because we enjoy the martyrdom of denying ourselves the pleasures of spending.We save because we only have the past to extrapolate. Much as we know that cycles turn, we look at the past, size up the experiences of those times, and provide for it as if the future would be similar. The young earners that experience a wave of opportunities and rising earnings, will only extrapolate that.As they say in behavioral finance, our forecast is just our position: we see the future just as we want to see it. We save because we see it with our limitations. We don’t see choices that we have not experienced so far. There is nothing wrong with the desire to save. Nor is there a problem with the propensity to not save. It all depends on how one sees income, and how one fits expenses into it. Today and in the unknown tomorrow. To each one their own.(The writer is Chairperson, Centre for Investment Education and Learning)
from Economic Times https://ift.tt/3rK9oKI
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