KARACHI: Having gone through the several mistakes that many Pakistanis make in their personal financial management, I would now like to begin on the all-important subject of creating a personal financial plan. This is something that most people seem to neglect to do early in life and then wonder why their mid-life crisis includes financial frustration.
The key to a successful financial future is to start early – very early. All students in college should begin charting out the major expenses that they anticipate over the course of their lives. This includes things like the education of their children, a house or apartment of their own and their retirement. It does not, under any circumstances, include your sister’s/your own wedding. For details on why spending large amounts of money on weddings is an insane idea, see the column dated April 19, 2010.
In order to have a clear financial plan, one needs to have a realistic expectation of the kind of goals one has for one’s lifestyle. For example, not everyone can afford a 1,000 square yard house in Defence (either Lahore or Karachi) and one must have some idea of the kind of house one is willing to live in based on their financial resources. If you are like most urban Pakistani professionals, chances are that you will not be able to afford a luxurious home on your salary and savings, even if you got a mortgage (more on that subject in future columns).
But there are several affordable apartments and even townhouses available in reasonably comfortable parts of whatever city you live in. A little research can go a long way in the real estate market. In the case of Karachi, for example, while that 1,000 square yard house in Defence can cost you a minimum of Rs20 million, an apartment in the same area can cost as little as Rs 2 million.
In addition, only plan on sending your children abroad to colleges if you can keep pace with their tuition bills (which increase by a rate substantially higher than the rate of inflation in the United States). It also helps to have fewer children and since you are now wise enough to not use your children as a retirement plan, you do not need to keep on spawning off-spring till you have a son.
All of the above factors will also determine how much cash you will need during your retirement years. If you work at an organisation that has a pension plan, count yourself as one of the lucky ones. But even if you do not, you can amass a substantial amount of money through a combination of savings and investments.
Speaking of savings...
Perhaps most importantly, young people should begin to create monthly budgets that include a substantial allocation towards savings. How substantial? Nothing less than 25% of one’s post-tax income should go towards savings. If that sounds like too much, then remember this rule: savings are far more important than consumption. If you are a Pakistani male under 30, chances are you can save a lot of money simply by giving up smoking. Those who do not smoke are probably more sensible with their money anyway. (Yes, I hate smokers.)
The savings should then be channelled towards investments, the easiest of which are mutual funds. Many asset management companies (the folks who manage mutual funds) have systematic investment plans that allow an investor to put in a fixed amount into a mutual fund every month. As stated earlier, I would recommend equity mutual funds for most young investors, which have the highest likelihood of delivering high returns over the long run, although they can be a bit of a rough ride during the short run.
The time horizon for retirement planning is roughly 30 to 40 years, depending on how old you are and when you plan to retire. Over this period of time, equity mutual funds can deliver markedly superior returns over any other form of investment. How superior? The KSE-100 index averaged 21% returns per year for the last 10 years. At those rates of return, Rs 1,000 invested every month can balloon to Rs5.6 million in 40 years (in present rupee terms, meaning after netting out the effect of the average 9% inflation over that period).
In short, Pakistanis need to do at least two things that go against our national character: plan for the long term and take risks. Only by doing so can we create a middle class in the country.