Savings in high interest rate environment

In case of price rise, discretionary expenses should be cut, funds directed towards essentials

KARACHI:

In the wake of current political and economic fiasco, Pakistanis are experiencing a period of life-time high interest rates.

The government has taken steps to curtail imports and reduced subsidies, alongside fiscal and quantitative tightening. Debate exists on the fallout of these steps with endless discussions on the right course to chart and the timing of the steps.

The current recessionary trend is global and has hit international demand substantially. The Covid period was a time of primarily supply shock/ shortages with potential exit from the situation as supply chain bottlenecks got hammered out.

The recent scenario is ‘demand-led’, resulting in overheating of various global economies. Consequently, retail prices are biting the pockets of the end-consumer, resulting in reduced sales and a supply glut.

Below is an attempt to chart a path that can be followed in these testing times.

Budgeting expenses

Starting point for any saving strategy to succeed is to plan and have a pre-decided list of expenses. In a high-inflation environment, it’s difficult to estimate the cost of groceries and utilities but listing them is the starting point.

Budgeting expenses helps ensure that financial obligations are met, desired lifestyle is achieved and overspending is avoided. Budgeting should cover all essential expenses like rent, utilities, transportation, groceries and loan repayments and also slice in discretionary expenses like dining out and entertainment.

Bifurcating between essentials and discretionary would ensure that in case of a price rise, discretionary expenses are reduced and funds are directed towards essentials.

Build an emergency fund

Alongside listing expenses or consumption that we plan to undertake, it’s important to plan for an “emergency fund”. Creation of this fund as part of the budgeting activity and considering this as current spending ensures that this is undertaken before we start gnawing on income flows for daily expenses.

To determine the size of the fund, the rule of thumb is to build a nest that covers at least three to six months’ worth of living expenses and some extras for emergency medical expenses. In the current period of high interest rates, return on the emergency fund will be higher, making it more lucrative to have this fund.

Saving goal

While targeting expenses, it is very important that we set various short- and long-term goals that we want to achieve in life and calculate the financial outlays for these.

Setting goals, working towards them, and achieving them would help us reach the pinnacle of success in life and potentially internal peace.

Saving money should become a habit, like brushing your teeth or exercising. It would be a good idea to discuss the goals with your partner, kids, and/or parents, ensuring that the entire family is aligned towards delivering the goal.

Set up auto-recurring transfers on your salary or income account to ensure that the targeted saving is taken off from the income account on day one. This would push us to cut down on discretionary expenses in case of any inflationary pressure rather than reducing savings.

Review your finances monthly or quarterly and make necessary adjustments as warranted by the broader economic situation. Adjustments to the saving speed may be required as we move ahead and get near or drift apart from the targeted funding.

Higher-yielding assets

The strategy is to ensure that your money works for you and one doesn’t get blinded by higher returns. Create a portfolio that attempts to beat inflation, resulting in a positive return on the consumption sacrificed.

Look for accounts offering competitive returns, low fees, and no minimum balance requirements.

It’s important to balance the risk while targeting to earn competitive returns. One should undertake research to understand the risks before investing.

Riskier and non-liquid assets should also be considered like term deposits, investments into T-bills/ PIBs/ Sukuks or into CDNS products, balanced or aggressive mutual funds, and direct equity. Consider consulting with a financial adviser to help identify investment opportunities aligned with your goals and risk tolerance.

Debt snowball or debt avalanche

Pay off high-interest debt, such as credit card debt or a personal loan, as quickly as possible. Consider using the debt snowball or debt avalanche method for repayment.

Debt snowball involves paying off the smallest debt first, then using the funds to pay off your next smallest debt, and so on. This method ensures we remain motivated as we knock debt off our list of payables.

Debt avalanche involves paying off your debt with the highest interest rate first, then using that payment to pay off your next highest interest rate debt, and so on. In a high interest rate environment, the debt avalanche method is preferred.

Two key guiding principles in the savings journey are i) Be disciplined ii) Be patient.

Saving money requires discipline and self-control. Stick to the budget and avoid unnecessary expenses.

Saving money takes time. Don’t get discouraged, keep saving and stay focused on the goals. Over time, savings will grow resulting in a better financial position.

The writer is a student of behavioural finance, a treasury & wealth management professional and a visiting faculty at IBA

 

Published in The Express Tribune, March 20^th, 2023.

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