Budgeting for Future Expense

Often we need to account for expenses that happen long in the future - like retirement or children's education / marriage. Here I present a few rules of thumb that I use to budget for these.

Rules of thumb

You can use items 1 and 2 for large expenses (like education or marriage) and item 3 for retirement planning.

1. If your requirement would cost 1 lakh today and it will be made Rs 25 years later, you can
• Save 25,000 today and be done or
• Save Rs 350 every month or
• Save Rs 85 every month and keep increasing every year in proportion to your salary.
2. If your requirement would cost 1 lakh today and it will be made Rs 10 years later, you can
• Save 55,000 today and be done or
• Save Rs 800 every month or
• Save Rs 450 every month and keep increasing every year in proportion to your salary.
3. If your retirement is 25 years away, save 25% of you expenses for retirement. If it is 10 years away, save 1.25 times your expenses.

Notes

These are some notes for people who may want to check these rules. Please feel free to ignore this section if you just want to use the rules.

1. I assume that the real rate of return is between 4% and 6%. These rates have been achieved over the past several decades in various index funds and are not too risky.
2. There is a well known rule called the rule of 72 which states that if the interest rate is x% than money doubles in roughly 72/x years. So with a 4% interest rate, it takes 19 years to double and with a 6% interest rate, it takes 25 years to double.
3. Given that life expectancy may increase, it is simplest to use only real returns during retirement. This ensures that you never run out of retirement funds.