Only when you have a buffer for emergencies and basic expenses, should you even think about investments
When you make your investment plans (or a financial plan), generally it is built on an increasing income scenario. That is, as your income increases, so do your investment contributions. Let’s say you were saving Rs 25,000 from your Rs 1 lakh monthly salary last year. So if your income rises by 10 per cent to Rs 1.1 lakh, then you should try to increase your investments by at least 10 per cent, i.e., to Rs 27,500.
But what about when you are faced with a pay cut? Recalibrate
Pay cuts are definitely better than losing your job suddenly. This is a high-impact event. So, unless you really have your expenses in check, a pay cut is tough to adjust to.
Unfortunately, pay cuts are being imposed these days due to the pandemic’s impact on various sectors and employers. So how should you deal with such an event?
The first thing to assess is the possibility of job loss in the near future. If your employer is forced to take the pay-cut route, and if things don’t improve for businesses soon, then job losses may be in the offing too. You need to accept this reality and prepare yourself for a job loss, too, now. As harsh as it may sound, this is necessary.
And if you already have a reasonably sized emergency fund in place, it should take care of you if that were to happen. But in the absence of one, people need to resort to cutting down expenses, dipping into savings, etc. So, even if this may sound ill-timed, the fact is that there really couldn’t have been a better example to highlight the importance of emergency fund than these pandemic-induced pay cuts.
The lockdown would have made you realize that the basic living expenses aren’t very high. Right? More money gets spent (at times) unnecessarily via discretionary expenses.
Segregate expense heads
So, sit down and identify which expenses are core ones and which aren’t. Expense identification and rationalization are important aspects of financial planning. And this is an ideal time to figure out what your critical, non-negotiable, core expenses are. Make a mental note that, after the pay cut, you will incur only these core expenses and not the discretionary ones for some time.
Only when you have a buffer for emergencies and money for basic expenses, should you even think about investments.
Take a small example. Let’s say you were earning Rs 1 lakh a month before the pay cut. Your expenses were Rs 40,000, EMIs were Rs 35,000 and you were investing Rs 25,000 per month. Now you face a 25 per cent pay cut and the new salary is Rs 75,000.
Now, after the pay cut, the EMI of Rs 35,000 will continue as it is. On assessment, you find that out of the regular expenses of Rs 40,000, only Rs 30,000 was for basic needs. So, that leaves only Rs 10,000 as surplus, which you can consider for investments. That too, only if you have an emergency buffer in place.
But what if there is almost no surplus left?
If you are unable to invest because of a lack of surplus, then stop making further investments for a few months. Don’t worry. It’s a pause. Nothing else. For now, it’s much more important to have immediate liquidity at hand. Once things normalize after a few months, you can bring your investments back on track.
And what if you have some surplus left to invest?
A pay cut demands that you reconsider some of your goals and re-evaluate whether they are important right now or you can postpone them to a later date.
So, reconsider all your goals that you were investing for earlier. Figure out which are the important short and medium term goals. Try to save for them first. The savings for long-term goals can be restarted later. A few months gap wouldn’t cause much harm to such goals. And for now, put your discretionary goals / expenses like car purchase, house renovation, vacations and their savings on hold.
And don’t take the pay cut personally. It is temporary and in no way a reflection of your capabilities. It is just that the employers are prioritizing their survival. It’s just a bend in the road and not the end.(The writer is the founder of StableInvestor.com)