Investing is primarily about accumulating wealth to meet non-discretionary future consumption. By this, we mean expenses that you will incur in the future that are essential for your family’s lifestyle.
Rarely do we initiate a process to save for future discretionary consumption—expenses that we would like to incur, but that are not essential for our basic living. In this article, we discuss about why and how you should set aside money for such expenses.
You typically save from your current income to meet your child’s education expenses when she enters college, to meet the down payment requirement to buy a house or to accumulate wealth for retirement. Such expenses can be termed as non-discretionary expenses—expenses that you have to necessarily incur.
What is, however, flexible is the amount that you will want to incur towards such expenses. You may, for instance, accumulate Rs 50 lakh in 10 years to pay for your child’s college tuition or you may decide to incur Rs 1 crore and send your child overseas for higher studies.
By contrast, discretionary expenses are those expenses which you can choose not to incur. You may, for instance, want to take your family on an exotic vacation every two years. Or you may want to entertain your spouse to fine dining at least once a month.
You will notice that we specifically refer to expenditure that does not result in asset acquisition. If you want to acquire a luxury boat or buy a vacation home, we prefer to classify such expenses as aspiration assets.
For the purpose of our discussion here, we refer discretionary expenses to mean non-asset-based expenses that you may want to incur more frequently than in the case of aspiration assets. The question is: Why and how should you set aside money for your discretionary expenses?
Discretionary imprest
Your satisfaction from spending Rs 2.5 lakh in a year on an exotic vacation will typically give you more satisfaction than spending the same amount of money annually on groceries! That said, balancing spending on current non-discretionary expenses and saving for the future is important, but not easy. To enable this balancing process, you should set-up a discretionary imprest account. The term imprest refers to the financial accounting system where the expense account is replenished with cash at periodic intervals. The process works as follows:
First, fix the money you want to carry in your discretionary imprest account. You should preferably have not more than two times your monthly expenses. Second, contributions to the imprest account can come from two sources. You can contribute not more than 5 per cent of your monthly savings to this account. Or you can fund the account with windfall money such as unexpected yearly incentives as well as reimbursement of expenses by your employer. Third, invest the money in multiple short-term bank fixed deposits. This provides you the flexibility to take the money when you need it and yet earn decent return on your investments. Fourth, redeem the deposits when you require money for discretionary expenses. Fifth, replenish your spending account with cash from the above-mentioned sources. And to ensure that you do wipe out your imprest account, maintain a balance of 10 per cent in the account.
Conclusion
Discretionary spending is an important part of your lifestyle requirement. You should, therefore, have a process that helps you spend money on such desires without affecting your current and future non-discretionary expenditure. You may choose to incur large discretionary expenses such as an expedition to the Antarctic. For such “lumpy” expenses, a target investment portfolio with a fixed time horizon would be effective. The imprest account is useful for not-so-lumpy periodic expenses. So, are you geared to spending on discretionary?
(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. Feedback may be sent to knowledge@thehindu.co.in )