Rule of '9-9-9' to make you rich
Published on Sat, Nov 26, 2011 at 11:40 |
Published on Sat, Nov 26, 2011 at 11:40 |
Source : Moneycontrol.com
Updated at Sat, Nov 26, 2011 at 11:48
Equitymaster.com
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US Presidential nominate, Herman Cain, had come up with a program titled '9-9-9' aimed at reforming the US tax system. The program was proposed to help the US economy out of its financial troubles. In essence, it proposed to have a 9% income tax, 9% business transaction tax and a 9% federal sales tax. Hence the connotation 9-9-9.
Whether the program gets approved or not, the connotation can actually be used in another way. As proposed by Forbes magazine, the rule of 9-9-9 can be used by people like us to increase our wealth. True, it is written keeping the people of America in mind, but we feel that if tweaked a bit, it is something that each of us can adopt in our lives.
How does it work?
Well it works in 3 steps. It helps to reduce your personal debt burden, reduces spending and increasing your saving. In short, it is the recipe of becoming richer.
Let's take a look at the 3 steps involved.
Step 1: Pay off all debts that have an interest rate of 9% or more.
You may read this and go "Ha! With the increasing interest rates ALL the debts would fall in this category". Well that is actually true. So we are going to tweak this rule a bit. Pay off all debt that has an interest rate higher than what you can earn by investing in a relatively risk-free investment. We are referring to the returns on the investment which is what you earn by holding on to the investment over a period of time.
The way this works is that suppose a relatively risk free investment gives you 12% returns (note we are talking of returns not the face value interest rate). And you have a loan on which you pay 11% interest. So it would be better for you to invest your money in the investment and use the interest income received to pay off the interest on the loan. Any loan that has a higher interest rate deserves to be paid back. Otherwise the interest liability just keeps on growing and your debt burden goes up over time (using compounding power of money ).
So once you have identified the loans that need to be paid off first, the next question is how much money should you put aside to pay off such loans? This is where steps 2 and 3 come in.
Step 2: Have at least 9 months of necessary expenses in savings
Everyone has their monthly expenses. This includes basics like food, travel, clothing, housing, etc. Excluding expenses on luxury, it would be a good idea to work out how much you need each month. At any point of time, it is necessary to put at least 9 months of necessary expenses in savings. These should ideally be completely risk free and easy to get. A savings bank account or a fixed deposit are usually good places to park these savings.
But here one may ask, with expenses going up almost daily, how does one set aside this huge quantum of savings?
Well the idea is no different from what economists and experts prescribe for the countries. You have to adopt austerity measures. Prioritize your expenses and cut back on anything and everything that you may regard as unnecessary and wasteful. True it would mean that you like in a frugal manner for sometime but at the end if you are able to build up more funds, then the whole process is totally worth it. Initially it may seem difficult but saving at least 2 -3 months of expenses is doable to start with. As you move higher in life and continue following these rules in a disciplined manner, even the 9 months' savings become achievable.
Step 3: Save 9% of your income each year for retirement
So once you are done with saving up to meet your expenses, you should be saving at least 9% of your total annual income for retirement. Again, this looks like a low savings rate for us Indians. But this is the bare minimum that one should try to achieve. These funds should ideally be parked in long term investment options depending on your risk taking appetite. And these should be kept for a long period of time. Imagine the kind of funds you would have at the end of 10 years or 15 or even 20. The power of compounding comes in and the funds multiply over the time period.
The balance that is left over is used to pay off your debt burden, which you have sorted out on the basis of the interest rates.
Following these steps may seem difficult. But followed diligently and with discipline, it does become possible. And with these steps, you would soon be debt free and have sustained savings. This in turn can compound over time leading to larger wealth for you.
(Equitymaster is a Mumbai-based independent equity research firm)
Updated at Sat, Nov 26, 2011 at 11:48
Equitymaster.com
======================================================
US Presidential nominate, Herman Cain, had come up with a program titled '9-9-9' aimed at reforming the US tax system. The program was proposed to help the US economy out of its financial troubles. In essence, it proposed to have a 9% income tax, 9% business transaction tax and a 9% federal sales tax. Hence the connotation 9-9-9.
Whether the program gets approved or not, the connotation can actually be used in another way. As proposed by Forbes magazine, the rule of 9-9-9 can be used by people like us to increase our wealth. True, it is written keeping the people of America in mind, but we feel that if tweaked a bit, it is something that each of us can adopt in our lives.
How does it work?
Well it works in 3 steps. It helps to reduce your personal debt burden, reduces spending and increasing your saving. In short, it is the recipe of becoming richer.
Let's take a look at the 3 steps involved.
Step 1: Pay off all debts that have an interest rate of 9% or more.
You may read this and go "Ha! With the increasing interest rates ALL the debts would fall in this category". Well that is actually true. So we are going to tweak this rule a bit. Pay off all debt that has an interest rate higher than what you can earn by investing in a relatively risk-free investment. We are referring to the returns on the investment which is what you earn by holding on to the investment over a period of time.
The way this works is that suppose a relatively risk free investment gives you 12% returns (note we are talking of returns not the face value interest rate). And you have a loan on which you pay 11% interest. So it would be better for you to invest your money in the investment and use the interest income received to pay off the interest on the loan. Any loan that has a higher interest rate deserves to be paid back. Otherwise the interest liability just keeps on growing and your debt burden goes up over time (using compounding power of money ).
So once you have identified the loans that need to be paid off first, the next question is how much money should you put aside to pay off such loans? This is where steps 2 and 3 come in.
Step 2: Have at least 9 months of necessary expenses in savings
Everyone has their monthly expenses. This includes basics like food, travel, clothing, housing, etc. Excluding expenses on luxury, it would be a good idea to work out how much you need each month. At any point of time, it is necessary to put at least 9 months of necessary expenses in savings. These should ideally be completely risk free and easy to get. A savings bank account or a fixed deposit are usually good places to park these savings.
But here one may ask, with expenses going up almost daily, how does one set aside this huge quantum of savings?
Well the idea is no different from what economists and experts prescribe for the countries. You have to adopt austerity measures. Prioritize your expenses and cut back on anything and everything that you may regard as unnecessary and wasteful. True it would mean that you like in a frugal manner for sometime but at the end if you are able to build up more funds, then the whole process is totally worth it. Initially it may seem difficult but saving at least 2 -3 months of expenses is doable to start with. As you move higher in life and continue following these rules in a disciplined manner, even the 9 months' savings become achievable.
Step 3: Save 9% of your income each year for retirement
So once you are done with saving up to meet your expenses, you should be saving at least 9% of your total annual income for retirement. Again, this looks like a low savings rate for us Indians. But this is the bare minimum that one should try to achieve. These funds should ideally be parked in long term investment options depending on your risk taking appetite. And these should be kept for a long period of time. Imagine the kind of funds you would have at the end of 10 years or 15 or even 20. The power of compounding comes in and the funds multiply over the time period.
The balance that is left over is used to pay off your debt burden, which you have sorted out on the basis of the interest rates.
Following these steps may seem difficult. But followed diligently and with discipline, it does become possible. And with these steps, you would soon be debt free and have sustained savings. This in turn can compound over time leading to larger wealth for you.
(Equitymaster is a Mumbai-based independent equity research firm)
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moneycontrol.com/news/planning/rule9-9-9-to-make-you-rich-_624819.html
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