THE RICHEST MAN IN BABYLON- PART II
You will not always get what you desire in life, but what you deserve.
The first part of this series on the book, “The Richest Man in Babylon” and the lessons contained therein, has been received very well by all of you. Before we dive into the next lesson, here is a recap of the four lessons we learnt last week.
- Pay Yourself First.
- Put the saved money to work.
- Go for prudent financial advice which includes your own financial education.
- Protection of, your capital and your life, family and assets.
We commence with the fifth lesson and that is –
5. Balance your Wants and Needs: The Spending – Investing (SI) Balance
What each of us calls our ‘necessary expenses’ will always grow to equal our incomes unless we protest to the contrary. Confuse not the necessary expenses with thy desires.
“Hazaaron khwaahishen aisee ki har khwaahish pe dam nikle; bahut nikle mere armaan lekin phir bhi kam nikle”.
Life is all about balance—as students, it was about “study and play”, as adults it is about “work and life”; even to remain healthy it is about a “balanced diet”. Like a balanced diet must contain protein, carbohydrates and fat, a balanced financial life must also address your needs (protein,) your savings (fat) and your wants (carbohydrates.) These three ingredients finally translate to spending and investing in life—spending to keep you healthy in the present and investing to keep you healthy in the future. Too much of indulgence in the present will adversely impact your future and too much of future consciousness will rob your present of the fun that you so richly deserve. After all, how long can you go on eating sprouts and boiled vegetables but at the same time how long can you afford to have a fat-rich diet?
Translated to our financial health, what should be our ideal balance? Let me introduce you to the 50:30:20 Model which is extremely doable due to its simplicity. It not only allows you to put together an optimum SI balance but also acts as a fitness checker as you go along major milestones in your life like marriage, childbirth, retirement and so on. The model has been beautifully explained by Elizabeth Warren and Amelia Warren Tyagi in their book ‘All Your Worth,’ another one of my recommended books.
So what is the 50:30:20 Model? Simply stated, one should limit one’s needs to 50 per cent and wants to 30 per cent of take-home pay (post-tax and mandatory deductions.) The balance of 20 per cent should be saved (read invested.) It is an extremely simple concept and applicable to everyone at any level of earning or stage of life. Of course, these are rules of thumb percentages and may undergo changes depending on specific situations, which are well covered in the book. What remains to be defined, is what constitute ‘needs’ and ‘wants?’ An extremely profound question whose answer may vary from person to person, but some guidelines could be laid down.
We start with ‘needs’, the 50 per cent stuff. Actually, they are very simple and one has to add just one to the well-known needs of Roti, Kapda aur Makaan (food, clothing and shelter.) The addition in the list is transportation as one needs to commute for work and play.
So far as the house is concerned, it includes the rent or the mortgage instalment one is paying for it. We will tackle the issue of buying a house in the next post because it is invariably the costliest and most enduring financial commitment that one makes but suffices to say here that the house rent or mortgage EMI has to fit in this 50 per cent bucket.
The clothing needs are obvious but must be restricted to fit within the overall 50 per cent limit. After all, a pair of sneakers may cost up to ₹8.5 lakhs (yes Nike Mag 2016 (auto lace) cost $12500 in an auction) but a decent one will be available upwards of ₹3000, so you get the drift?
Food is slightly tricky because it straddles both wants and needs. A home-cooked meal may cost only a fraction of the cost of a pizza with a couple of beers; a cup of tea at home may cost a hundredth of a Starbucks Tall Latte. Incidentally, we will devote a full post on the Latte Factor later.
Transportation again needs to be contained within the budget of 50 per cent. A cab every day to and from the office will obviously cost much more than the metro or some other public transport. Using office provided or pool transport is always a better option. I must also hasten to add that if you are eyeing that swanky bike or fancy car out there, be notified that the EMI of the bike or car must come out of this 50 per cent pool since it will squarely fit into the 50 per cent category of transportation. Who said life is easy?
Needs will also include your other basic requirements like communication (telephone bills) other utilities like electricity and gas, the money required for insurance, medical expenses (the reason why health insurance becomes so critical) and other mandatory legal expenses like minimum due on your credit card or school fees.
The bottom line for ‘needs’ should be: Will I keep on spending on these things if I lose my job tomorrow? The second question to ask should be: Can I live without this thing for the next 6 months? If the answer to the first question is yes and to the second one is no, it qualifies as a need.
We will tackle the ‘savings’ next. It is the simplest (and the toughest) part of this paradigm and one has to just follow the ‘Pay Yourself First’ principle discussed earlier. I feel that a 20 per cent allocation should be considered the bare minimum to ensure quality education for your children and dignified retirement for you. Anything more will be welcome but if one stretches to save more than 30 per cent of the take-home pay, one is drifting towards boiled vegetables and sprout diet kind of lifestyle; no fun. Just sock 20 per cent of your take-home pay every month and year till retirement increasing the amount each year by 6 per cent to cater for inflation and you will retire rich. Where and how to save or invest for various life goals is a major and interesting question which I will keep on covering in these posts but if you have read my books, it occupies a major portion of both my books.
“All men are burdened with more desires than they can gratify.”
That leaves us with the nebulous issue of ‘wants.’ Wants vary from person to person but few will remain common like outings and movies, gifts for near and dear ones, DTH and cable TV set up, good clothing, a glass of beer and so on. Specific wants could also include keeping a pet or buying a particular type of furniture or painting. Nevertheless, the wants must be kept in balance by balancing the needs and savings. So if one is methodically paying 20 per cent to oneself first and is clear about one’s ‘needs’ on which 50 per cent is being spent, the rest of the money is available for ‘wants.’
Another important issue is understanding and getting rid of the “Present Bias”- I need it now, by developing something called “Delayed Gratification”. There was an interesting experiment in the 1960s, by a Stanford professor named Walter Mischel, called The Marshmallow Experiment. Walter and his team got together and tested hundreds of children aged 4 to 5 years in a very innovative manner.
Each child was brought into a private room, made to sit down in a chair and a marshmallow was placed in front of them on a table. The researchers then made a deal with the child- they were going to go out of the room and leave the child alone with the marshmallow. If the child didn’t eat the marshmallow while the researcher was away, he will be rewarded with an extra one – meaning two marshmallows. However, if the child couldn’t control himself and ate the marshmallow, there would be no reward.
The researchers then left the room for 15 minutes. The experiment was recorded on a secret camera whose footage later found broadly three groups of children. The first jumped up from their chair and ate the marshmallow as soon as the researcher had left. The second group of children squirmed in their chairs, looked longingly at the marshmallow, looked away from it, but finally couldn’t contain themselves and ate the marshmallow. The third group of children patiently waited for the full 15 minutes until the researcher returned and then gleefully devoured the two marshmallows (including the one obtained as a reward.) The report of this experiment was published in 1972, but the most interesting part came much later.
The researchers followed the lives of all the children over the next 40 odd years. What came out was surprising – the set of children who showed the trait of Delayed Gratification were found to be having a better academic record, lower levels of substance abuse, better social skills and better performance on all the parameters of life and success. If you are a parent with children of an impressionable age (or even grown-ups), please impress upon them the results of this study.
Patience is a virtue which always, without fail, results in handsome rewards in life. Since we are discussing finances here, if we teach our children to curb this Present Bias and inculcate a discipline of Delayed Gratification, they will religiously follow the 20% savings rule throughout their life. Believe me, the power of compounding can reward you with humongous gains. In the next post, I will give an anecdote about the power of compounding which will blow your mind. Remember, it’s not important how much we make but how much of it we keep.
I have devoted this entire post on this single, most important lesson which not only impacts our finances but life in general. Please mull over it and discuss with your children including the fields in which the concept of Delayed Gratification could pay us dividends.
 You may also like to study the “Li Kashing model” which is a 30:20:15:10:25 model. It will improve your financial IQ.
 Clason George: The Richest Man in Babylon.
Image: Nathalie Dieterle for NPR
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